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INTRODUCTION TO 
ECONOMICS 



BY 

ALVIN S. JOHNSON, Ph,D. 

SOMETIME ADJUNCT PROFESSOR OF ECONOMICS IN COLUMBIA UNIVERSITY 

ASSOCIATE PROFESSOR OF ECONOMICS IN THE UNIVERSITY OF CHICAGO 

PROFESSOR OF ECONOMICS IN THE UNIVERSITIES OF NEBRASKA 

TEXAS, STANFORD AND CORNELL 



REVISED 



D. C. HEATH & CO., PUBLISHERS 

BOSTON NEW YORK CHICAGO 






COPYRIGHT, 1909 AND 1922 
BY D. C. HEATH & CO. 



2E2 



MADE IN THE UNITED STATES 

m i2 1522 

©CI,A6745«6 



PREFACE 

The first edition of this book was prepared some twelve 
years ago, at the end of a long period of active theoretical 
controversy in American economics. It can not be said that 
the issues in dispute had come to rest in a general agreement. 
Rather, the majority of economists were wearied of contro- 
versy and sought an escape from it in concrete studies of the 
practical problems of economic policy or business technique. 
I sympathized strongly with the movement toward more prac- 
tical inquiry. I believed that there was small profit to be had 
from further theoretical refinements; that what was especially 
needed was quantitative analysis of the living economic forces. 

Long experience as a teacher of economics had, however, 
convinced me that the most satisfactory approach to the prac- 
tical problems of economics is by way of a well coordinated 
statement of principles. The striking characteristic of eco- 
nomic life is its organic character; and the student who has 
not had the organic nature of the economic structure impressed 
upon his mind, runs grave risks of proceeding from his special 
problem to generalizations that are either hopelessly negative, 
or sentimentally Utopian. Every economic problem is tangled 
up with other problems. The living wage, for example, ap- 
pears at first sight to be a fairly independent problem, to be 
handled in terms of the cost of housing, clothing, and food, 
with definite specifications as to the qualities as well as quanti- 
ties required. But such an inquiry leads inevitably to prac- 
tical conclusions. It is found, we will say, that three fifths of 
our workers fall short of a living wage. Is it human for an 
investigator to stop with the establishment of this fact, and to 
refrain from making recommendations for remedying the con- 
dition? Wages must be raised, he is pretty sure to conclude. 

iii 



iv PREFACE 

At whose expense, however: the employer's, or the consumer's; 
at the expense of capital, of the owners of natural wealth? Or 
is it possible that wages can be raised without expense to any- 
one? Obviously, our simple problem has plunged into a forest 
of other problems, and will pretty certainly be lost unless it 
finds a path blazed by principles. 

It was such considerations that led me to believe that what 
the general student needed, as an introduction to economic 
science, was not a more or less loosely connected discussion of 
practical problems, but a system of principles developed just as 
logically and rigorously as pedagogic requirements would per- 
mit. As all economists agree, value is the clue to the general 
problems of the science. It is through repercussions on value 
that changes in any part of the economic system are trans- 
mitted to all other parts of the system. A student who can 
handle the problem of value can attain to tenable conclusions 
on any problem of economics, provided that he is possessed of 
the pertinent facts. One who can not handle the problem of 
value may have a world of facts at his command, and yet not 
be able to make of himself anything better than a barrier to 
clear thinking and sane policy. Therefore, I threw the prob- 
lem of value into the foreground of my discussion, and spared 
no pains in exhibiting it in all its chief phases in the fields of 
price and distribution. 

In the course of twelve years I have naturally been forced to 
modify many of my opinions on practical economic affairs and 
to reject altogether some opinions I once held. But I am now 
even more firmly convinced than before that the best approach 
to economics is by way of a thorough study of principles. And 
I think that many more teachers of economics will agree with 
me to-day than was the case in 1910, for the war and the re- 
construction period have thrown into the focus of active popu- 
lar interest a host of problems that demand the rigorous appli- 
cation of principles. The mechanics of international trade, 
problems of taxation and finance, of money and credit are now 
felt to be vital by millions of men. As always happens when 
economic problems acquire popular interest, there has been a 



PREFACE V 

great efflorescence of question-begging argument, of seductive 
conclusions, and Utopian schemes. And as the mist of con- 
fused thought begins to Hft, it becomes clear that the solid 
contributions of economics in this period have been those 
which were built upon the accepted body of economic 
principles. 

In this revision I have left the greater part of the text intact. 
Here and there I have inserted new material which seemed 
pertinent, and in one case a whole chapter, on Management. 
Innumerable minor changes have been made, usually with the 
object of clearing up obscurities that might confuse the 
student; occasionally with the object of softening the out- 
lines of a conclusion which I now see was too absolute and 

uncompromising. 

ALVIN S. JOHNSON 
Apeil, 1922 



CONTENTS 



CHAPTER PAGE 

I. THE NATURE OF ECONOMIC SCIENCE i 

I. Significance of the desire for wealth, i. — 2. The desire for 
wealth not altogether a selfish motive, 3. — 3. Definition of 
wealth, 5. — 4. Human services as wealth, 5. — 5. Objects of 
desire that are not wealth, 6. — 6. Present and future wants in 
their relation to wealth, 7. — 7. Value the common characteris- 
tic of all forms of wealth, 8. — 8. Definition of economics, 8. — 9. 
Economic significance of the laws governing human wants, 
9. — 10. The production of wealth, 10. — 11. The distribution 
of wealth, 10. — 12. The practical objects of economic science, 
II. — 13. The relations of economics and politics, 12. — 14. 
Economics as a developing science, 14. — 15. The exchange econ- 
omy, 15. — 16. Competition, 16, — 17. Restrictions upon 
competition, 18. — 18. Economic classes, 19. — 19. Significance 
of the laws of price, 21. — 20. Summary, 22. 

II. UTILITY, VALUE AND PRICE 24 

I. Significance of the development of wants, 24. — 2. Elastic- 
ity of wants, 25. — 3. Law of diminishing intensity of wants, 
26. — 4. Utility, 27. — '5. Law of diminishing utility, 28. — 6. 
Marginal utility, 30. — 7. Effective utihty, 30. — 8. Economic 
function of comparison of utilities, 32. — 9. Personal value, 
33. — 10. Socialization of personal ' values through imitation, 
34. — II. Socialization of personal values through the art of 
salesmanship, 36. — 12. Socialization of personal values through 
exchange, 36. — 13. Personal exchange value, 37. — 14. Price, 
40. — 15. The determination of price in a market, 40. — 16. 
Demand and supply, 44. — 17. Quahfication of the principle 
that marginal buyers and sellers control prices, 45. — 18. Sum- 
mary, 47. 

III. NORMAL COMPETITIVE PRICE 49 

I. Fluctuations in market prices, 49. — 2. Fluctuations in the 
prices of perishable commodities contrasted with fluctuations 
in prices of imperishable ones, 50. — 3. Effect of extension of the 
market upon price fluctuations, 50. — 4. The normal price level, 
51. — 5. Influences determining the normal price level, 53. — 6. 
Relation of cost of production to normal price, 54. — 7. Conflict 
of interest of the individual producers, 56. — 8. Conditions upon 

vii 



viii CONTENTS 

CHAPTER PAGE 

which the adjustment of prices to the normal level depends, 
58. — 9. Deviations from the normal price level in agricultural pro- 
ductions, 59. — 10. Relation of large antecedent costs to price de- 
viations, 60. — II. Joint products, 61. — 12. Forces determining 
the short-period normal price level, 63. — 13. The long-period 
normal price level, 65. — 14. Summary, 66. 

IV. MONOPOLY PRICE 68 

I. Price control dependent upon control of supply, 68. — 2. Defi- 
nition of monopoly, 69. — 3. Monopolies established through com- 
binations of producers, 70. — 4. Monopolies established through 
control of an essential element in production, 71. — 5. Intimi- 
dation as a means of monopoly control, 72. — 6. Influence of 
competition upon partial monopolies, 74. — 7. Law of monopoly 
price, 75. — 8. Influence of elasticity of demand upon monopoly 
price, 77. — 9. Permanent and temporary monopolies compared, 
78. — ID. Classification of consumers for purposes of monopoly 
exploitation, 80. — 11. Monopohstic price discriminations in 
favor of foreign consumers, 82. — 12. Charging what the traffic 
will bear, 83. — 13. Limits upon monopolistic exploitation, 
84. — 14. Summary, 85. 

V. THE COST OF PRODUCTION 87 

I. Prices dependent upon the cost of production, 87. — 2. Laws 
governing the prices of the materials of production, 88. — 3. 
Fluctuations in the price of finished products are reflected in 
fluctuations in the prices of producers' goods, 89. — 4. The 
benefits of a rise in price of a finished product may rest per- 
manently with the producers of the crudest material entering 
into that product, 90. — 5. The rent of land suitable for one 
use only fluctuates with the price of its product, 91. — 6. The 
wages of labor are sometimes directly dependent upon the price 
of the product of labor, 93. — 7. Relation to wages of the cost of 
other elements in production, 94. — 8. Alternative uses of pro- 
ducer's goods as affecting their relation to the price of a partic- 
ular product, 97. — 9. Competition of producing districts, 98. 
— 10. Price-determining and price-determined costs, 100. — 11. 
Summary, 102. 

VL THE LAW OF DIMINISHING RETURNS 103 

I. Increase in the output of an industry is limited by increase in 
cost of some factor or factors, 103. — 2. Increase in the business 
of a single establishment usually limited by the difficulty of in- 
creasing one or more factors, 104. — 3. In most cases the out- 
put of an establishment can be increased only at more than pro- 
portionate increase in cost, 106. — 4. Diminishing returns in 
agriculture, 107. — 5. Diminishing returns operate more severely 
jn some fprnis of agriculture than in others, 109, — 6. Diminish- 



CONTENTS IX 

CHAPTER PAGE 

ing returns in urban improvements, 109. — 7. Diminishing re- 
turns in transportation, iii, — 8. When the amount of labor 
increases when the amount of capital remains fixed, the law 
of diminishing returns becomes operative, 112. — 9. Universal 
application of the law of diminishing returns, 113. — 10. The 
test of economy in production, 114. — n. Influences which 
counteract the tendency toward diminishing returns, 116. — 12. 
Summar}'", 117. 

VII. THE SPECIALIZATION OF ECONOMIC FUNCTIONS 119 

I. Economic functions undifferentiated under primitive con- 
ditions, 119. — 2. Exchange as the original force making for 
differentiation of economic functions, 120. — 3. Effect of pro- 
duction for a general market, 121. — 4. Dependence of economic 
differentiation upctn the form of commercial organization, 123. 

— 5, Effect of improvements in transportation upon economic 
differentiation, 124. — 6. Effect of increasing population, 125. 

— 7. Relation of the form of economic organization to economic 
differentiation, 126. — 8. Business advantages arising from 
the division of labor, 127. — 9. Social advantages arising from 
the division of labor, 129. — to. Disadvantages of the division 
of labor, 130. — ir. Division of labor as a force counteracting 
diminishing returns, 132. — 12. Summary, 134. 

VIII. MANAGEMENT 135 

I. Management under primitive conditions, 135. — 2. Manage- 
ment differentiated from ownership, 137. — 3. Management 
at present fails to reach efficiency, 139, — 4. Good management 
determines costs, 140. — 5. Good management saves material, 
142. — 6. Good management plans continuous process of pro- 
duction, 143. — 7. Good management adapts tools and methods 
to secure economical production, 144. — 8. Good management 
secures the good- will and cooperation of the workmen, 147. — 9. 
Good management produces more goods and increases social wel- 
fare, 150. — 10. Good management sometimes improved by con- 
centrated action, sometimes by standardization, 151. — 11. 
Summary, 154. 

IX. THE CONCENTRATION OF INDUSTRY 155 

I. Increase in size of the business establishment, 155. — 2. 
Concentration dependent upon the facilities for assembling 
materials, 156. — 3. Concentration limited by the extent of the 
market, 157. — 4, Effect upon concentration of improvements 
in transportation, 158. — 5. Effect upon concentration of the 
growth of large fortunes, 158. — 6. The corporation, 159. — 7. 
The large establishment can make the fullest use of the division 
of labor, 160. — 8. It can avail itself of the most effective ma- 
chinery, 161. — 9. It enjoys cheaper power, 162. — 10. It wastes 



X CONTENTS 

CHAPTER PAGE 

less material, 163. — 11. It can develop valuable by-products 
from waste, 163. — 12. It buys more cheaply and sells at better 
prices, 164. — 13. It secures lower rates of transportation, 165. 

— 14. It pays exceptionally low rates of interest, 166. — 15. 
The advantages of concentration vary from industry to in- 
dustry, 166. — 16. The gains from concentration are subject 
to the law of diminishing returns, 168. — 17. Summary, 170. 

X. BUSINESS COMBINATIONS 171 

I. Present tendency toward combination, 171. — 2. Combina- 
tion of competing business units, 172. — 3. Industrial integration, 
172. — 4. Temporary combinations, 173. — 5. Partial combina- 
tions, 174. — 6. Consolidation, 176. — 7. Pooling, 176. — 8. 
The Trust, 177. — 9. The holding company, 178. — 10. Con- 
solidation increases productive efficiency, 179. — 11. It en- 
courages speciahzation, 180. — 12. It reduces costs of ship- 
ment, 181. — 13. It makes possible a better adjustment of supply 
and demand, 182. — 14. It reduces cost of marketing, 183. — • 
15. It reduces interest charges on borrowed capital, 183. — 16. 
Within limits, consolidation makes possible the control of prices, 
184. — ^17. Summary, 185. 

XI. COMPETITIVE WAGES 187 

I. Definition of labor, 187. — 2. Definition of wages, 188. — 3. 
The importance of the problem of contract wages, 189. — ■4. 
Wages vary according to the conditions under which labor is 
employed, 190. — 5. Equal wages for equal tasks, 191. — 6. 
Wages cannot exceed the marginal productivity of labor, 192. 

— 7. Under competition cannot long be less than the marginal 
product of labor, 193. — 8. Effect upon wages of the increase in 
the niunber of laborers, 195. — 9. Effect upon wages of improve- 
ments in production, 196. — 10. A reduction in rate of interest 
raises wages, 197. — 11. Effect upon wages of personal effi- 
ciency, 198. — 12. Non-competing classes of laborers, 200. 

— 13. Effect upon wages of the apportionment of new laborers, 
201. — 14. Permanent influences affecting the distribution 
of labor, 203. — 15. The standard of living, 208. — 16. The 
special standards of living operate only indirectly, 211. — 17. 
Summary, 213. 

XII. WAGES AS AFFECTED BY LABOR ORGANIZATION 214 
I. Inferiority of the laborer in bargaining power, 214. — 2. 
Labor organization as a means of increasing the bargaining power 
of labor, 217. — 3. The trade union, 220. — 4. The closed shop, 
220. — 5. Apprenticeship regulations, 222. — 6. The importance 
of trade union funds, 223. — 7. Alliances between trade unions, 
224. — 8. National labor organizations, 225. — 9. The Ameri- 
can Federation of Labor, 226. — lo. The strike, 227. — 11, 



CONTENTS xi 

CHAPTER PAGE 

The boycott, 228. — 12. The relation of trade unionism to the 
strike and boycott, 229. — 13. Collective bargaining, 230. — 14. 
Voluntary arbitration, 231. — 15. Public opinion and arbitra- 
tion, 232. — 16. Compulsory arbitration, 233. — 17, Labor 
organization and the competitive law of wages, 234. — 18. 
Restriction of output as a cause of reduced wages, 235. — ig. 
Summary, 236. 

XIII. THE PRODUCTIVITY OF Cx\PITAL 238 

I. Capital goods, 238. — 2. Capital a fund of productive wealth, 
239- — 3- The permanence of capital, 240. — 4. Acquisitive 
productive capital, 242. — 5. Artificial and natural capital, 
243. — 6. Saving, 243. — 7. The growth of natural capital, 245. 

— 8. The productivity of capital goods, 245. — 9. The productiv- 
ity of capital, 247. — 10. The productivity of capital determined 
at the margin, 247. — 11. Effects of an increase in capital, 250. 

— 12. Law of diminishing productivity of capital, 251. — 13. 
Influences counteracting the law of diminishing productivity 
of capital, 253. — 14. Effect upon the productivity of natural 
capital of increase in artificial capital, 253, — 15. Equalization 
of returns to capital through revaluation, 255. — 16. Equaliza- 
tion of returns to capital through mobility of capital, 255. — 17. 
Barrier preventing the free flow of capital from industry to in- 
dustry, 257. — ^18. Summary, 260. 

XIV. RENT, INTEREST AND CAPITALIZATION 262 

I. Popular meaning of the term rent, 262. — 2. The traditional 
scientific use of the term, 263. — 3. Rent as the product of a 
capital good, 264. — 4. Rent restricted to the product of durable 
capital goods, 264. — 5. Rent and interest, 265. — 6. Rent 
as a residue, 266. — 7. The determination of the rent of one of 
several goods entering into a permanent combination, 268. — 
8. The rent of a reproducible capital good tends to equal interest 
on the cost of replacing the good, 269. — 9. The relation of 
ground rent to wages and interest on artificial capital, 270. — 
10. The relation of the prices of the products of the land to 
the rent of the land, 273. — 11. The tendency of ground rents 
to rise, 275. — 12. Capitalization, 275, — 13. Method of ascer- 
taining the amount of capital in reproducible and irreproduci- 
ble goods, 276. — 14. Effect of an increase of artificial capital 
upon the volume of land, 279, — 15. Summary, 280, 

XV. ENTERPRISE AND BUSINESS PROFITS 281 

I. Business opportunities, 281. — 2. Enterprise, 282. — 3. The 
relation between economic changes and the opportunities for 
enterprise, 284. — 4. Enterprise a risk, 285. — 5. Enterprise 
and imperfect competition, 286. — 6 . Definition of profit, 
286. — 7. The nature of profits, 287. — 8. Profits due to ab- 



xii CONTENTS 

CHAPTER PAGE 

normally low wages and interest, 289. — 9. Profits due to the 
transfer of labor and capital from one environment to another, 
290. — 10. Profits due to the transfer of an industry from one ' 
environment to another, 291. — 11. Conditions under which 
enterprisers gain profits, 293. — 12. Profit a temporary income, 
294. — 13. Monopoly profits may have permanence, 295. — 14. 
Monopoly may be capitalized, 297. — 15. Function of com- 
petitive profit, 298. — 16. The evil of effect of monopoly profits, 
299. — 17. Profiteering, 301. — 18. Summary, 303. 

XVI. MONEY 305 

I. Definition of money, 305. — 2, Origin of money, 306. — 3. 
Functions of money, 307. — 4. Qualities that money should have, 
308. — 5. Lack of uniformity in money without government 
control, 310. — 6. Functions of government relative to the 
monetary system, 311. — 7. Methods of maintaining parity, 
312. — 8. Gresham's law, 314. — 9. The value of money, 
315. — 10. Measurement of fluctuations in the value of money, 
316. — II. Effects of changes in the quantity of money, 316. 
— 12. Effect on prices of the issue of paper money, 319. — 13. 
Effect on prices of the introduction of substitutes for money, 
320. — 14. Effect of changes in the volume of business upon 
the value of money, 320. — 15. The effects of an increase in the 
supply of money not capable, 322. — 16. Importance of changes 
in the price level, 323. — 17. Government regulation of the 
money supply, 326. — 18. The silver movement, 327. — 19. 
Probable effects of free silver, 327. — 20. International bi- 
metalism, 328. — 21. Decline of the silver party, 329. — 22. " 
Paper money, 329. — 23. Forces regulating the value of gold, 
333. — 24. Summary, 334. 

XVII. FINANCIAL INSTITUTIONS: THE BANK 337 

I. Finance as the placing of capital, 337. — 2. Forms of capital 
placement, 338. — 3. The loan, 339. — 4. Disguised loans, 
340. — 5. Credit, 340. — 6. Credit instruments, 341. — 7. De- 
mand for a supply of loanable capital, 342. — 8. Functions 
of the bank, 344. — 9. Bank loans regarded as the purchase of 
credit instruments, 347. — 10. Kinds of investments suitable 
for banking purposes, 348. — 11. Deposits arising out of loans, 
349. — 12. The clearing system, 351. — 13. Bank reserves, 
353. — 14. Risks incurred by bank depositors, 355. — 15. 
Bank notes, 357. — 16. Restrictions upon note issue, 359. — 
17. Notes and deposits as currency, 360. — 18. Summary, 361. 

XVIII. OTHER FINANCIAL INSTITUTIONS. 364 

I. Permanent investment of free capital, 364. — 2. Demand 
for long-term investment funds, 364. — 3. Supply of long- 
term funds, 366. — 4. Instruments of long-term investments, 



CONTENTS xiii 

CHAPTER PAGE 

367. — 5. Variation in security of investments, 369. — 6. 
Variation in. transferability of investments, 369. — 7. Produc- 
tiveness of an investment, 370. — 8. Effect of risk upon pro- 
ductiveness, 371. — 9. Effect of difficulty of transfer upon pro- 
ductiveness, 372. — 10. Machinery for placing capital, 372. 
— II. Stock exchange, 374. — 12. Speculation, 374. — 13. Eco- 
nomic function of speculation, 376. — 14. Underwriting syndi- 
cates, 377. — 15. The investment company, 378. — 16. The 
savings bank, 379. — 17. The building and loan association, 
381. — 18. The land bank, 382. — 19. The life insurance com- 
pany, 384. — 20. Complexity of the financial mechanism, 
385. — 21. Summary, 386. 

XIX. INTERNATIONAL TRADE AND FOREIGN EXCHANGE 388 

I. The basis of permanent trade, 388. — 2. Local and inter- 
regional trade, 390. — 3. Ifiterregional trade based upon abso- 
lute differences in productive powers, 391. — 4. Interregional 
trade based upon relative differences, 392. — 5. Interregional 
trade may originate in differences in character of population, 
393. — 6. It may originate in differences of relative supply of 
natural agents, 394. — 7. It ma}^ originate in differences in supply 
of capital, 395. — 8. It may originate in differences of traditions 
of workmanship, 397. — 9. Fluctuations in value of money give 
rise to transitory trade, 397. — 10. The foreign trade of a modern 
nation is based upon a variety of conditions, 399. — 11. Rela- 
tive not absolute advantages in production give rise to exporta- 
tion, 400. — 12. Relative advantages are reflected in money 
cost of production, 401. — 13. Application of the principles of 
distribution to foreign trade, 402. — 14. Trade between countries 
is essentially barter, 404. — 15. Bills of exchange, 408. — 16. 
Fluctuations in the price of bills of exchange, 409. — 17. Con- 
ditions determining the price of bills, 410. — 18. Exchange on 
all foreign points tends to fluctuate uniformly, 412. — 19. Effect 
of increase of exports or imports upon the price of foreign bills, 
412. — 20. Effect upon exports and imports of the fluctua- 
tions of foreign bills, 413. — 21. Exportation and importation of 
gold, 414. — 22. Summary, 415. 

XX. THE REGULATION OF FOREIGN TRADE 417 

I. Foreign trade regulated by taxation, 417. — 2. Revenue 
and protective duties, 418. — 3. Popularity of revenue duties 
on imports, 420. — 4. Import duties borne by the consumer, 
422. — 5. Protective duties as a means of maintaining the 
money supply, 424. — 6. Fallacy of discouraging importa- 
tion from countries which do not take commodities in exchange, 
425. — 7. Fallacy of patronizing home industry, 427. — 8. 
General protection an impossibihty, 429. — 9. Wages not 
dependent upon protection, 430. — 10. Protection may re- 



xiv CONTENTS 

CHAPTER PAGE 

duce real wages, 431. — 11. Some of the ejffects of protec- 
tion are seen, while others are unseen, 434, — 12. Protection 
may increase the product of industry if the government has 
better business ability than the body of private enterprisers, 
435. — 13. Protection may aid productive industries in over- 
coming the hardships of infancy, 436. — 14. Protection should 
be withdrawn from an estabhshed industry, 437. — 15. Diffi- 
culty in determining when protection becomes unnecessary, 
437. — 16. Inadvisability of establishing industries that re- 
quire permanent protection, 438. — 17. Protection as a means 
of preserving natural resources, 440. — 18. Protection as a means 
of preserving the vigor of the working population, 442. — 19. 
Protection as a means of making a country independent in 
time of war, 442. — 20. Inadvisability of seeking complete 
self-sufficiency, 444. — 21. Retaliatory duties, 445. — 22. Sum- 
mary, 446. 

XXI. THE RELx\TIONS OF GOVERNMENT TO THE ECO- 
NOMIC ORGANIZATION 448 

I. Interdependence of law and economics, 448. — 2. Free 
enterprise, 449. — 3. Criticism of the system of free enter- 
prise, 450. — 4. The question of productive efficiency, 451. — 
5. The question of distribution, 452. — 6. Distribution as 
between recipients of profit, 453. — 7. As between laborers, 
454. — 8. No standard of justice ascertainable in distribution 
between different classes, 454. — 9. Inequalities in bargaining 
powers vitiate the results of free contract, 455. — • 10. Free enter- 
prise approaches justice only when competition rules, 456. — 11. 
Need for government interference, 457. — 12. Regulation of qual- 
ities of goods and services, 458. — 13. Regulation of the prices 
of goods or services, ,460. — 14. Regulation of the conditions of 
employment, 462. — 15. Regulation of wages, 464. — 16. Regu- 
lations of relations of landlord and tenant, creditor and borrower, 
director and ^ stockholder, 465. — 17. Governmental regulation 
not incompatible with free enterprise, 468. — 18, Government 
ownership for revenue, 469. — 19. Government ownership for 
purposes of regulation, 470. — 20, Industries producing inap- 
propriable utilities, 471. — 21. Conditions under which public 
replaces private enterprises, 475. — 22. Summary, 476. 

INDEX 477 J 



INTRODUCTION TO ECONOMICS 

CHAPTER I 
THE NATURE OF ECONOMIC SCIENCE 

1. The desire for wealth has in all ages been one 
of the principal motives of human action. 

From the earliest time of which we have record a great 
part of the activity of man has been occupied with the 
production or acquisition of wealth — material objects and 
personal services upon the control of which human welfare 
depends, or seems to depend. In the long ages of savagery 
and barbarism primitive man was engaged in a ceaseless 
struggle with nature for the bare means of existence — • 
food, clothing, and shelter. Limited as were the suppHes 
afforded by nature, a savage tribe never long enjoyed 
them in peace; other tribes coveted the hunting grounds, 
or the bays where shellfish abounded; the rich pastures, 
or the groves of fruit-bearing trees. Hence the difficulty 
of obtaining from nature the means of subsistence was 
aggravated by constant warfare between tribe and tribe. 
A struggle for mere existence against nature and against 
hostile tribes — • such was the hfe of primitive man. 

From century to century man learned to equip himself 
better for the struggle for existence. Tools, at first rudely 
wrought from stone, later from the metals, greatly in- 
creased his productive power. A yet greater step in ad- 
vance was made when animals were domesticated, and a 
certain and steady food supply tc^fek^he place of the pre- 
carious products of the chase. The cultivation of roots 



2 INTRODUCTION TO ECONOMICS 

and grains that had in their wild state yielded scanty re- 
turns to the gatherer marked another stage of progress. 
Methods were crude^ and the tasks of pastoral and agri- 
cultural life exceedingly laborious — a condition which 
gave rise to the enslaving of captives taken in war. With 
the increase in productive power, Hmited classes were 
freed from the economic struggle and were enabled to 
devote their energy to ends less intimately connected with 
the pursuit of wealth — politics, literature, art, reHgious 
organization. Every advance in the productive power of 
society has increased the relative number of those who are 
free to engage in activities that add nothing to the stock of 
bare necessities. 

It remains true, nevertheless, that the great majority of 
men are mainly occupied with the pursuit of wealth. This 
is in large measure due to the fact that a man's desire for 
material welfare is capable of indefinite expansion. Merely 
to possess food sufficient to satisfy hunger does not content 
him; the food must be pleasing to the palate as well as 
nutritious. Warm clothing is an excellent thing; but civi- 
lized man demands that his clothes be of good appearance 
as well as comfortable. A sod house on the prairie is con- 
structed with no great amount of labor and almost no 
expense; in such a house one may defy the worst storms 
of winter and the hottest winds of summer. Yet the 
modern dweller on the plains would scorn such an abode; 
his home must present an appearance of comfort and 
prosperity. To stand well with one's fellows is to most 
men hardly less important than life itself, and in all 
human history a significant factor in winning and retaining 
the esteem of others has been the possession of proper 
attire and other personal appointments. There is a 
standard of wealth consumption which each little group of 
associates in society is under some sort of compulsion to 
attain. If my neighbors and friends all have fine houses, I 



THE NATURE OF ECONOMIC SCIENCE 3 

cannot enter my humble dwelling without a sense of in- 
feriority. If they are well dressed, I desire to be equally 
well dressed. If they are wise or learned or cultured, I 
naturally strive to emulate them in this respect also. But 
one cannot be well clad or well housed, one cannot without 
great difficulty be wise or learned or cultured, unless one can 
command a fair amount of wealth, an amount far in excess 
of the bare needs of existence. Under modern conditions 
wealth has become a means — though, of course, not the 
only means — to most of the things which one can desire. 
And as it is not in the nature of man to be content for any 
long time with what he possesses and what he has attained, 
it is inevitable that his desire for wealth, which is so potent 
a means for further attainment, should continue unabated. 
While to most men wealth is a means to the satisfaction 
of ulterior ends, it may become an end in itself. Not only 
to the mean spirited, who easily become infected with the 
miser's diseased yearning for wealth, but also to men of 
more active, more generous quahty. It is necessary to 
allow for force of habit. A man has given the better part 
of his Hfe, let us say, to estabHshing himself on a firm 
economic foundation. He has pursued wealth so long as 
a means that it becomes a habit with him. He finds sat- 
isfaction in still pursuing it, although he has no need for it. 
2. A man desires wealth not only for the satis- 
faction that it may give himself, hut also for 
the satisfaction it may give those whose interests 
he regards as his own. 
Nothing is more common than to stigmatize the desire 
for wealth as a narrowly selfish motive. As a fact there 
are comparatively few men who desire wealth merely for 
the sake of the personal gratification that they expect to ' 
derive from it. The normal man is more desirous that his 
wife and children should enjoy the comforts of wealth 
than that he should enjoy them himself. There are some 



4 INTRODUCTION TO ECONOMICS 

persons whose desire for wealth is animated chiefly by the 
needs of a group of persons in no way connected with 
them by ties of kinship. The founders of free hospitals, 
orphan asylums, sailors' homes, and the like are types of 
this class. Some persons have sympathies so broad as to 
include all the citizens of a country within the group for 
whom they desire the benefits of wealth. The greatness 
of Pericles consisted partly in his ardor for advancing 
the material prosperity of the Athenians, even through 
the exploitation of allied states. 

We may therefore say that the desire for wealth ani- 
mates the purest and most unselfish of men as well as 
the most sordid. The desire for wealth is a desire for 
means to ends, and these may be good or evil. The phi- 
lanthropist who wishes to found a home for invalid 
children must have wealth, just as the voluptuary who 
desires a palace of all delights to please his jaded senses. 
The economic motive animates both; very likely the 
philanthropist desires wealth the more ardently. What 
differentiates the two is the end which the wealth is 
meant to subserve. To assert, then, that most men are 
in great measure actuated by economic motives is not 
to assert that they are selfish or sordid. It is merely to 
assert that wealth has been placed between man and the 
satisfaction of most of his desires; that as he seeks to 
attain any end whatsoever, he will seek to possess the 
means to that end. 

The desire for wealth enters into the greater part of 
the activities of most men in modern society. But it is 
very far from the exclusive motive, even in activities that 
seem to have no other object than the acquisition of 
wealth. A very strong desire is to create: to stamp one's 
personality upon the environment. Often such desires 
can be satisfied through economic activity. The good 
artisan puts many refining touches on his product, not 



THE NATURE OF ECONOMIC SCIENCE 5 

foi the sake of the pay he receives, but to satisfy his own 
instinct of excellence. The captain of industry often loses 
sight of the fact that his business is primarily a profit- 
making enterprise and exults in it as a thing of beauty or 
power, worth heavy sacrifices, if necessary. 

3. Wealth consists of all material objects and 

human services which can he made subject to 
man's control and upon which man depends 
for the satisfaction of his wants. 
The apples in one's orchard are wealth; they are sub- 
ject to one's control, and their consumption yields satis- 
faction. Even if their owner does not care for apples, 
they are wealth to him if through exchanging them he 
can gain control of other objects capable of satisfying his 
wants. The trees which bear the apples and the land 
upon which they grow are also wealth, as they are neces- 
sary means to the production of the fruit. Wealth, then, 
includes those things that satisfy desires immediately, or 
consumers^ goods, and those things that serve as means 
for producing objects of immediate desire, or producers^ 
goods. Both classes together constitute economic goods. 

4. Human services may satisfy wants directly or 

indirectly. 

The services of an actor, a musician, or an orator re- 
sult in the immediate satisfaction of desire. The serv- 
ices of a mason, a plasterer, or a carpenter embody 
themselves in material form. Bricks in the form of a 
house have a utility superior to that of an equal number 
of bricks in a material yard, and the measure of this 
superiority is the measure of the services of the 
bricklayer. 

In summing up the annual production of wealth of a 
given country, it is necessary to take account of the serv- 
ices yielding immediate satisfaction. It is not usually 
necessary to take account of the services resulting in the 



6 INTRODUCTION TO ECONOMICS 

indirect satisfaction of desires, as these are as a rule em- 
bodied in material objects, which are always taken into 
account in estimating the production of wealth. The rule 
admits numerous exceptions. The services of instruction, 
especially technical instruction, are analogous to the 
services of those who construct machines and implements 
for use in production. A country has added to its effec- 
tive wealth in the course of a year if through training it 
has embodied new productive capacity in its young men 
md women. A country with a generally skilled popula- 
tion is richer than one with a population wholly un- 
skilled, just as a country possessed of abundant machin- 
ery and tools is richer than one without these. Usually, 
however, economists shrink from admitting human qual- 
ities, however acquired, to the category of wealth. The 
conception seems to smack of slavery. 

5. Nothing can he wealth unless the total supply is 
so narrowly limited that every part of it is 
necessary to satisfy existing wants. 

The sun in spring satisfies an intense want of mine; so 
also do showers in the dry season. But these things are 
not part of my wealth, as they are not subject to my 
control. The air I breathe satisfies my most intense 
want, but it is not wealth. Though my life depends 
upon a constant supply of air, it cannot be said to de- 
pend upon any specific part of the existing volume. If 
my fire consumes part of the oxygen in the air of my 
room, thus, for all practical purposes, destroying the air, 
a fresh supply flows in through the open window, with- 
out effort or thought on my part. Since no particular 
part of the supply of air is of any special importance, 
air cannot be wealth. 

In a newly settled country standing timber is often so 
plentiful that all possible need for it for firewood or for 
lumber falls far short of absorbing the entire supply. In 



THE NATURE OF ECONOMIC SCIENCE 7 

such circumstances standing timber can have no place in 
the Hst of objects composing wealth. If one man's wood 
were swept by fire he would find no difficulty in securing 
timber gratis from other men. When land itself is so 
plentiful, relatively to the need for it, that not all the 
best land is occupied, no man's welfare is dependent upon 
his control over a particular tract of land. If in the 
early part of the nineteenth century a squatter in the 
Ohio valley had been dispossessed from the land which 
he occupied, he would have lost nothing but the improve- 
ments which he had fixed in the soil. The land, there- 
fore, was no part of his wealth. 

6. The wants that endow a class of objects with the 
quality of wealth may originate in present 
needs or in anticipated future needs. 

The coal fields of Utah are capable of producing a far 
greater supply of coal than the persons who now have 
access to those fields can possibly use. If man lived in 
the present alone, those coal fields could not be classed 
as wealth. But it is generally recognized that at some 
future time the mines in that region will be unable to 
supply all need for fuel. The anticipated future need 
affects the present calculations of men and leads them to 
class the coal fields among the objects at present consti- 
tuting wealth. In like manner, land fit only for building 
sites in the vicinity of a growing city acquires a place 
among objects of wealth even when it is far in excess of 
the present needs of the population. Indeed, much the 
greater part of the wealth of a modern country is designed 
to satisfy future, not present, needs; and the greater the 
wealth and the business capacity of a people, the greater 
will be the proportion of its wealth deriving its value 
from future needs. 



8 INTRODUCTION TO ECONOMICS 

7. Value is the one quality that all forms of wealth 

have in common. 
The various objects that compose the wealth of an in- 
dividual or of a society form a heterogeneous mass, and, 
from a physical point of view, have no characteristics in 
common. What could be more dissimilar, physically con- 
sidered, than a steam engine and the music of an orches- 
tra? From the point of view of human need, however, 
they have something in common. Both may be desired; 
and the desire for one may be measured in terms of that 
for the other. Both are valuable; the one may be twice 
as valuable as the other. In this case we should say that 
the one represents twice as much wealth as the other. 
Value is the universal characteristic of wealth, and it is 
in terms of value alone that wealth can be measured. 

8. Economics is the science which deals with 

wealth in its most general aspect; namely, its 
value aspect. 

Gold and silver are forms of wealth. They have well- 
marked physical characteristics which distinguish each 
from the other and from all other physical objects. These 
characteristics are not, however, of direct concern to eco- 
nomics. Each possesses value, and this fact is of imme- 
diate importance to economic science. That an ounce of 
gold is worth more than twenty ounces of silver is an 
economic fact; that silver is harder or whiter than gold 
is not an economic fact. True, differences in physical 
characteristics may account in part for differences in 
value; but that physical differences are not a sufficient 
explanation of differences in value is clearly shown by 
the fact that the former remain constant, while the latter 
change from day to day. 

There is a body of principles determining the proper 
use of each form of iron and steel. One kind of steel may 
properly be used for rails, another kind may not be. 



THE NATURE OF ECONOMIC SCIENCE 9 

These laws and principles, however, are not a part of 
economics. They fall properly under the science of met- 
allurgy. The science of agriculture treats of the various 
economic plants, of the physical and chemical properties 
of agricultural products, of their distribution over the 
earth and of the uses to which they are adapted. This 
science, however, is no part of economics. An inquiry 
into the value of iron or of corn, or into the value of the 
indirect goods that are employed or used up in the pro- 
duction of iron or corn, would properly fall within the 
domain of economic science. 

9. Economic science derives many of its premises 
from the laws governing human wants or de- 
sires. 

Economics is the science of wealth. Nothing can be 
wealth — that is, possess value — unless it is desired, and 
the degree of desire determines in large measure 
the degree of value. There are some things that are de- 
sired intensely if their supply is narrowly limited, while, 
if their supply becomes very great, they are scarcely de- 
sired at all. Diamonds fall in this class. Other things 
are not desired very intensely even if their supply is small; 
if the supply is vastly increased, the desire for each part 
of the supply is not greatly reduced. This is especially 
true of things that can be used as substitutes for other 
things already widely used, as aluminum vessels for ves- 
sels of copper, iron, etc. With the progress in wealth 
some things come to be desired more intensely, other 
things less intensely. It has been told — probably by a 
romancer, but the point remains valid — that after the 
Russian Revolution a peasant was arrested for carrying 
to his home a lean joint of goat flesh, wrapped in a price- 
less painting cut from its frame in some pillaged palace. 
The peasant was arrested not for his mistreatment of the 
painting, but for having contraband meat wrapped in it. 



lo INTRODUCTION TO ECONOMICS 

If ever the peasant becomes rich he will look back with 
amazement to the relative values he fixed on meat and 
paintings, in the time of famine. Objects for future use 
are desired less intensely under one set of conditions than 
under another. We see, then, that in order to explain 
values it is necessary to take account of the laws govern- 
ing human wants. These laws in so far as they are 
treated in economics are grouped under the head of the 
''Consumption of Wealth." 

10. Economics deals with the general laws govern- 

ing the production of wealth. 
There are laws governing the production of wealth that 
are operative in all branches of industry, or at any rate, 
in a wide range of industries. Everywhere we find a 
tendency toward more narrow specialization of function 
on the part of the laborer; everywhere a tendency to 
substitute machine production for hand production. In 
a large number of industries we find the business estab- 
lishment increasing in average size from decade to dec- 
ade. In many industries an increase in the amount of 
product may be had only at a disproportionate increase 
in labor and expense. These laws and related ones are 
grouped by economists under the head of the ''Produc- 
tion of Wealth." 

11. Economics deals with the distribution of wealth 

among the different classes of which society 
is composed. 
The most prominent characteristic of modern indus- 
trial life is that commodities are produced, as a rule, 
through the joint efforts of many individuals. There was 
a time when the blacksmith smelted his own iron and 
controlled each stage in the process until the finished nail 
or horseshoe was in the consumer's hands. To-day, 
probably a thousand men have cooperated in the pro- 
duction of even so simple an article as a horseshoe. The 



THE NATURE OF ECONOMIC SCIENCE ii 

value thus produced must be distributed in some way 
among the various producers. Those who have contrib- 
uted labor receive wages; those who have contributed 
capital receive interest. What determines how large a 
share of the total value shall go to the laborers, how 
large a share to the owners of capital? There are general 
principles governing this distribution, and these form per- 
haps the most interesting and important part of econom- 
ics. These laws are grouped by economists under the 
head, ''The Distribution of Wealth." 

12. Economics is a practical science; its chief 

function is to throw light upon questions of 

public policy. 
Economics as a distinct science took its rise in studies 
concerning taxation and public finance. In early modern 
times the expenditures of government in most European 
states were steadily increasing. The various princes vied 
with one another in the splendor of their palaces and in 
the number and brilliancy of their personal following; the 
cost of maintaining the tranquilhty of the nation at home, 
and its dignity and influence in foreign lands, became 
heavier from decade to decade. More than all, methods 
of warfare by land and by sea were changing, and military 
success was coming to depend quite as much upon the 
size of the war chest as upon the valor of the soldiers. 
These new expenditures could be met only through taxa- 
tion; accordingly, it became a very practical matter for 
the statesman to devise means for increasing the pros- 
perity of a nation in order to increase its capacity for 
paying taxes. As the precious metals seemed to be the 
most convenient and the most stable form of wealth, it 
was the aim of the statesman to provide these in abun- 
dance. European countries, having no important mines 
of silver and gold, could secure these metals only through 
foreign trade. Hence the kernel of early modern eco- 



12 INTRODUCTION TO ECONOMICS 

nomic policy was the regulation of foreign trade, with a 
view to bringing into a country large supplies of treasure. 
These regulations formed a system which in the end be- 
came burdensome in the extreme; their futility and in- 
juriousness were exposed in the latter half of the eight- 
eenth century by the Economistes in France and by Adam 
Smith in Great Britain, whose writings first placed eco- 
nomics on a scientific basis. 

Through the nineteenth century economic discussion 
has progressed from one practical problem to another — 
money and banking, trade unionism, socialism, monopoly, 
etc. The chief function of the science is still, as in its 
earliest period, to ascertain what economic policy of gov- 
ernment will be most conducive to the general welfare. 
Although it is known as the '^ science of wealth," it is not 
the function of economics to instruct individuals how they 
may best acquire wealth. Its principal aim has been 
attained when it has thrown all possible light upon the 
economic problems which a state, and its members as 
citizens of a state, may need to solve. 

13. Most of the political problems of the present 
time are economic in their nature. 

The importance of economics to the citizen of a mod- 
ern state is clearly seen when we enumerate the issues 
that have held a prominent place in national politics. 
Since the founding of the republic there has been no 
presidential campaign in which the tariff has not been an 
issue. It is an active issue to-day. The relation of the 
federal government to the banking system was an im- 
portant issue in the early nineteenth century, in the 
period of the Civil War and again in the first decade and 
a half of the present century. The money question was 
potent in national politics from the Civil War through 
the end of the nineteenth century. The trust problem, 
the railway problem, the shipping subsidy question, have 



THE NATURE OF ECONOMIC SCIENCE 13 

exercised the last generation of legislators without ever 
attaining to a state of final rest. 

The Great War, with its tremendous enthusiasms and 
zeal for sacrifice, was, viewed in the large, a colossal anti- 
economic phenomenon. Nevertheless, in every warring 
country economic policy was given its place alongside of 
military strategy in the national concern. Indeed, such 
phrases as "the economic front" became commonplace. 
The whole economic power of the belligerents had to be 
deployed in the struggle. The oversubscription of a 
national loan was hailed with the enthusiasm of a battle 
won. And since the war we have had it impressed upon 
us that no peace treaty ends the economic repercussions 
of war. Industrial and agricultural depression, a dis- 
ordered state of international trade, taxation that presses 
heavily upon us, form the background of our political life 
to-day. 

Most of us have at some time speculated upon the ap- 
parent injustice in the distribution of rewards and serv- 
ices under the existing economic system. Is it right 
that the unskilled laborers, whose hours are long, and 
whose toil is hard and uninteresting, should receive .only 
the smallest pittance, while the successful lawyer or ar- 
chitect receives a princely income for work that may 
afford him the greatest pleasure? Many able thinkers 
have utterly condemned the existing economic system 
because of this inequality of rewards; they would sub- 
stitute a plan of sharing which would give to each accord- 
ing to the time spent or according to the degree of exer- 
tion. Certainly, this would increase the welfare of many 
who now have far too little; it might not seriously in- 
jure those who have more than is necessary for comfort- 
able existence. Yet could such a change be made with- 
out setting in motion influences which in the end would 
leave the rich poor and the poor more wretched than 



14 INTRODUCTION TO ECONOMICS 

they now are? The question is one that cannot be an- 
swered without a thorough study of the laws governing 
the production and distribution of wealth under modern 
conditions. 

It is now clear why economic study, though of recent 
origin, is prosecuted with more zeal than almost any other 
department of science. It is concerned with one of the 
most vital of all subjects — the general welfare. With- 
out economic science the existing constitution of society 
cannot be understood; unless based upon an adequate 
understanding of economic laws, attempts at practical 
reform of recognized evils are likely to do more harm than 
good. 

14. Economics must ever remain a developing body 
of thought, since economic life, which it seeks 
to explain, is constantly changing. 

Had a Greek philosopher attempted a systematic trea- 
tise on economics, we should find in it comparatively 
little that would assist us in solving the problems of to- 
day. Such a treatise would have dwelt at length upon 
the proper management of slaves, and the principles 
governing their value. It would have paid slight atten- 
tion to the principles governing wages, since free labor 
was comparatively unimportant in ancient Greece. It 
would have devoted very little space to capital and inter- 
est, as capital was slightly developed, and the taking of 
interest an infrequent phenomenon. Even exchange 
value, or price, would have received scant attention, 
since most commodities were consumed by the producer, 
instead of being placed on the market, as to-day. So we 
may surmise that the economic science of the present day 
will, some hundred years hence, prove almost devoid of 
practical interest. The economics of each generation 
must be based upon the prevailing system of wealth pro- 
duction and distribution. 



THE NATURE OF ECONOMIC SCIENCE 15 

15. The fundamental characteristic of the exist- 
ing economic system is that men produce 
goods, not for their own use, hut for sale. 

Throughout the periods of savagery and barbarism 
men Hved in small groups, which produced, through the 
chase, agriculture, and pasturage, practically everything 
that the members of the group consumed. Whether the 
group prospered or fared ill depended upon the weather, 
the fertility of the soil, the quantity and character of 
game, the relation to other groups — whether tribute was 
given or received. Within the group the relative welfare 
of each member depended to a certain extent upon his own 
prowess and efficiency; perhaps to a greater extent upon 
the tribal customs in accordance with which the common 
products of the group were distributed among its mem- 
bers. In the civilized states of antiquity a somewhat 
similar condition of affairs existed. Industry was based 
on slavery; the lord of a landed estate produced by slave 
labor almost everything that was needed on the estate. 
His welfare depended upon the amount and fertility of the 
land he possessed, the number of his slaves and his skill 
in managing them, the state of the weather, and freedom 
from hostile invasion. So, also, in the mediaeval villages. 
They were self-sufficing; the welfare of the community 
depended upon natural forces and the energy of the mem- 
bers of the community and their capacity for coopera- 
tion. Each individual depended for his welfare partly 
upon the same conditions, partly upon village custom in 
the apportionment of services and rewards. 

With the rise of modern trade a significant change took 
place in economic life. In greater and greater measure 
men engaged in production for distant markets, instead of 
for their own use. Under such conditions welfare de- 
pended not only upon the producer's energy and success 
in the creation of goods. It depended also in large meas- 



i6 INTRODUCTION TO ECONOMICS 

ure upon the price of the goods which were sent to 
market. The transition from production for one's own 
use to production for the market took place at various 
times in different countries and in different industries. 
In some branches of production it is only recently that 
the change has been effected. Thus the production of 
bread, formerly almost everywhere carried on in the house- 
hold for consumption there, has in the cities become an 
independent branch of industry, carried on for supplying 
a market, just as the production of shoes, cloth, or iron. 

The striking characteristic of modern economic hfe, 
then, is that men produce goods for the market. The 
employee in a shoe factory will very probably never wear 
any of the shoes he helps to produce; if the maker of 
clothes ever works on garments for himself, this is the 
exception to the rule of his daily labor. The farmer con- 
sumes little, if any, of the wheat that he raises; the wool- 
grower rarely spins and works up into cloth for his own use 
the product of his flocks. The modern economic system 
is therefore called an exchange economy, for it is through 
exchange of goods that each man gets the commodities 
that he needs. And with the rise of the exchange econ- 
omy a new set of laws of wealth and welfare has come 
into operation. The welfare of a farmer under modern 
conditions depends in some degree upon his own energy 
and intelligence, and in some degree upon the weather. 
But in a very large degree it depends upon the price at 
which he can sell his products. A high price of iron brings 
prosperity to all the classes engaged in the production of 
iron, as a low price involves them in loss and distress. 

16. A second characteristic of the modern eco- 
nomic system is competition in the sale 
and purchase of goods. 

When men first began to produce goods for sale, we 
may suppose that they had fairly definite views as to the 



THE NATURE OF ECONOMIC SCIENCE 17 

minimum price they would take and the maximum which 
they might reasonably seek, and that the margin between 
minimum and maximum was not wide. At any rate we 
know that in mediaeval times the producer was animated 
by the ideal of a fair and just price; to demand more 
than this was extortion; to accept less was a humiliation. 
This spirit prevailed, however, only in dealings with 
fellow- townsmen. To compel strangers to pay more than 
a fair price, and to force strangers to accept less than a 
fair price for their wares, was regarded as entirely legit- 
imate. As trade developed it assumed more and more 
the character of trade between strangers, each party to a 
transaction seeking to gain the largest possible benefit 
from it. 

Naturally that buyer was in the most favorable posi- 
tion who could pit one seller against another. Each 
seller would be forced to scale down his prices lest the 
other seller consummate an advantageous bargain. Sim- 
ilarly, that seller was fortunate who could pit one buyer 
against another. This was competition in its crudest 
form. In this form it exists to-day in auction rooms, 
stock exchanges, and in certain branches of retail trade. 

A seller may find himself alone in the presence of a 
buyer, yet both may be subject to the influence of compe- 
tition. The seller knows that the buyer can probably 
find another seller of the same or similar wares; the buyer 
knows that the seller can find other buyers. Accordingly, 
the action of each is controlled, in a measure, by the pos- 
sible action of persons who are not present and have no 
knowledge of the particular transaction in which they are 
engaged. This form of competition is more or less effec- 
tive according to the number of transactions of a given 
kind occurring in a community. No grocer can sell sugar 
at a price much in excess of that fixed by other grocers; 
no farmer can hold out for an excessively high price for 



i8 INTRODUCTION TO ECONOMICS 

his wheat. The seller of an old mansion is less narrowly 
limited in his demands by competition of this kind, as the 
buyer must choose between the mansion and some other 
kind of house. On the whole, it may be said that with 
the development of industry a constantly greater propor- 
tion of the goods bought and sold are of such a character 
that competition enters into the determination of their 
prices. 

Competition may assume a yet subtler form. In small 
towns petty dealers often evince a spirit of hostility to 
the occasional circus, because the circus "takes money 
away from the town." It is clear that the money spent 
at the circus cannot be spent for candy and soda water 
and other similar goods. The circus is thus really a com- 
petitor of the petty trader. The latter must give goods 
of better quality, or goods at lower prices, to prevent pen- 
nies from being hoarded for circus day. The principle 
involved in this illustration is that every seller is a com- 
petitor of every other seller; every buyer of every other 
buyer. An exchange economy inevitably entails compe- 
tition. 

17. Competition is always subject to more or less 
conscious restraint. Where this restraint is 
effective, monopoly exists. 

In mediaeval and early modern times the producers and 
traders of each town claimed the right to exclude stran- 
gers from buying or selling within the town, except under 
restrictions that effectively prevented them from compet- 
ing for the ordinary trade of the town. Each citizen was 
compelled by law and custom to refrain from acts that 
would impair his fellow-citizens' chances of securing ''fair 
prices." Early modern trade with barbarous and half- 
civilized peoples was also carried on under regulations 
calculated to restrain competition. Each European coun- 
try claimed the exclusive right of trading with certain 



THE NATURE OF ECONOMIC SCIENCE ' 19 

regions — Spain with Spanish America, England with 
British America and parts of the East Indies, Holland 
with the Dutch East Indies, etc. Nor were all citizens of 
these countries permitted to participate in the trade with 
their respective colonies; companies of traders were 
formed and were given exclusive privileges, insuring them 
the benefits of non-competitive conditions. In recent 
years every modern nation has witnessed the formation 
of combinations of producers with the object of limiting 
competition. Many of these combinations are successful 
in controlling, to a certain extent, the prices of their prod- 
ucts. These combinations are popularly known as mo- 
nopolies. They are none the less subject to the form of 
competition last described in the foregoing section. 

18. A third characteristic of the modern economic 
system is the formation of classes based 
upon economic function. 

Every society which has passed beyond the most prim- 
itive stage has been composed of classes. Master and 
slave, lord and serf, Norman and Saxon — such are some 
of the class distinctions with which history has familiar- 
ized us. Under modern conditions class distinctions are 
formed on other lines. One class of men gain their Hve- 
lihood by labor; another by the ownership of property; 
a third by placing labor and wealth in productive com- 
binations — laborers, capitalists, and enterprisers. This 
differentiation of classes is by no means complete, and 
probably never will be. Most laborers own a little prop- 
erty; most capitalists perform labor; most enterprisers 
are at the same time both laborers and capitalists. 
Nevertheless, the differentiation is clearly enough marked 
for all practical purposes. It is a natural result of modern 
conditions of production. So long as each man produced 
goods for his own use, the tools and appliances which he 
used were of necessity simple. To cut enough wood for 



20 • INTRODUCTION TO ECONOMICS 

one's own use did not require a very expensive ax; to 
furnish boards for one's own dwelling required only a 
handsaw, to be worked by two men. Spinning wheels 
and looms were Ukewise of the simplest make. These 
tools and appliances could be made by the workman him- 
self, or secured through exchange at small sacrifice. Ac- 
cordingly, the laborer as a rule owned the implements he 
worked with. In early modern times, although produc- 
tion for the market had become fairly common, the means 
of production still remained in the worker's hands. The 
increasing demand for products, however, soon led to the 
introduction of more expensive tools, and at last to the 
invention of machinery. Every step in this direction 
made it more difficult for the worker to provide himself 
with the means of production. So these had to be sup- 
plied by persons of wealth — capitalists. Under present 
conditions manufacturing industry in almost all its 
branches requires so large an expenditure for equipment 
that no single laborer can own the tools and machines he 
works with; nor is it often possible for a group of labor- 
ers to equip themselves for production through combin- 
ing their small savings. The capital outlay for a mill 
employing a hundred workmen is usually far in excess of 
what a hundred workmen can accumulate. Industry 
must therefore be conducted by wage laborers and em- 
ployer-capitalists. In many cases those who possess 
capital are not in a position to use it directly in business. 
The widows and orphan children of wealthy men are 
the clearest case in point. But there are great numbers 
of men and women who simply prefer to devote their 
attention to other things than business operations. Pos- 
sessing wealth enough for all their personal requirements, 
they may choose to live in luxurious ease, to try their 
fortune as sculptors or painters or poets, to engage in 
scientific research or polar expeditions. These persons 



THE NATURE OF ECONOMIC SCIENCE 21 

form a class more or less distinct. As their capital is 
employed in industry without their personal management, 
we may differentiate them from the employer-capitaHsts 
and describe their economic position as that of capitalist 
pure and simple. 

19. The laws of price are the governing principle 
in modern economic life. 

A farmer or a manufacturer is popularly said to ''put a 
price" upon his products. In the majority of cases, how- 
ever, what the seller really does is to make a choice be- 
tween selling at a given price or keeping his goods unsold. 
Except in comparatively rare cases there is a market price 
for goods which the buyers and sellers must accept if they 
desire to engage in business at all, and over this price 
no single person has any perceptible control. Yet prices 
do not exist apart from the action of men; they are the 
creation of man in society. Many persons, each acting 
with a view to his own interest, offer wheat for sale; 
many persons stand ready to buy it. The price of wheat 
is fixed as a result of the offers and demands of all per- 
sons who sell or buy wheat. It is therefore a social phe- 
nomenon — the creation of all society, or of a large part 
of it. And so it is with almost all prices. They are set 
by society. Hence the laws of price are properly called 
the laws of social economics, or of political economy. 

Under modern conditions the prosperity of each in- 
dustry as a whole depends largely upon the prices of its 
products. Within each industry the prosperity of each 
laborer, capitaHst, or employer depends in great degree 
upon the way in which the total product of the industry 
is divided. And here again we encounter social laws. 
There is a general rate of wages, which the laborer must 
accept if he wishes employment. In the same way, there 
is a general rate of interest. No one man exercises any 
appreciable influence in fixing these rates; they are the 



22 INTRODUCTION TO ECONOMICS 

resultant of the actions of all those who have labor to sell 
or capital to lend, on the one hand, and on the other 
hand, of those who desire to hire laborers or to borrow 
capital. 

The influence of price extends even farther. In large 
measure the laws of price determine what each of us shall 
do; they fix one's place of residence as well as his occupa- 
tion. If the price of glass is high, and remains high for a 
considerable period of time, high profits and high wages 
are possible in the glass industry. New establishments 
will be opened; boys and young men who otherwise 
would have engaged in other industries become glass 
blowers. By fixing a high price on glass, society, as it 
were, decrees that more persons and more capital shall be 
devoted to that industry. If coal and other sources of 
power are exceptionally cheap in a given locahty, if con- 
ditions of transportation are exceptionally favorable, large 
profits may be made by manufacturers in that locahty; 
they increase their investments and new capital flows in 
from less favored districts. A city is built, and the popu- 
lation that was formerly scattered in hamlets and country 
is under a sort of compulsion to congregate there. Why 
are our cities becoming greater and greater? The social 
laws of price decree it. If we would understand just why 
modern society presents a given form, our inquiry must 
take into account, as perhaps the most important factor, 
these laws of price. 

20. Summary. 

Economics is the science which treats of wealth — the 
material objects and human services which contribute to 
human welfare, and are therefore valued. The history of 
mankind is largely a record of progress in the power of 
producing wealth and the development of institutions for 
the distribution of wealth among the individuals compos- 
ing society. 



THE NATURE OF ECONOMIC SCIENCE 23 

Economic science begins with a study of the desires 
which give rise to economic activity and the values which 
originate in these desires. It deals, further, with the gen- 
eral laws governing the production of wealth and its dis- 
tribution among the various classes in society. The 
practical object of the science is the establishing of prin- 
ciples upon which organized society must act in order to 
maintain and increase the general well-being. 

The economic problems of any historical period can be 
understood only with reference to the underlying condi- 
tions characterizing the economic life of that period. In 
order to appreciate . the significance of modern economic 
problems, it is necessary to ascertain the fundamental char- 
acteristics of modern economic life. These are: (i) Pro- 
duction of goods and services, not for the use of the 
producer, but for sale; (2) Competition in the purchase 
and sale of goods and services; (3) The existence of 
classes based upon economic function — ^ laborers, capitalists, 
and enterprisers. The last two characteristics are, in a 
sense, corollaries of the first. 

The key to an understanding of the existing economic 
system is to be found in the laws governing the prices of 
commodities and services. The prices of goods are for the 
most part beyond the control of individuals; they may be 
said to be determined by society as a whole. The laws of 
price are therefore properly described as social laws; and 
the body of thought dealing with these laws is known as 
social economics. 



CHAPTER II 
UTILITY, VALUE, AND PRICE 

1. Economic evolution is, in large measure, de- 
pendent upon the development of wants. 

Man is distinguished from all other living creatures by 
the number and complexity of his wants. The lowest 
savage requires better shelter and more varied and nutri- 
tious food than his next of kin in the animal world. The 
wants of the savage are, however, few and simple as com- 
pared with those of civilized man. An extraordinary run 
of fish, an exceptionally good season for game, may leave 
the savage with all his wants practically satisfied. Men 
who have had occasion to employ workmen of half-civi- 
lized races complain that as soon as the workman has re- 
ceived wages enough to supply his wants for a few days, 
he ceases to take interest in his work, and very soon quits 
his employment, to resume it again only when driven by 
the goad of hunger. Civilized man, on the other hand, 
seldom suffers chronically from lack of means to satisfy 
hunger; he is, however, constantly aware of some want 
that remains unsatisfied, and the higher the state of civi- 
lization, the greater the number of wants that are effec- 
tive enough to incite a man to activity. The normal man 
in an American city limits his toil only when he feels that 
this is necessary in order to preserve his powers for 
future labor, and in many instances does not Hmit it 
even then. He overworks, often, without any better 
reason than that he does not know when to stop. 
Even our pleasures are selected largely with a view to 

increasing our working capacity. 

24 



i 



UTILITY, VALUE, AND PRICE 25 

Not only do the wants of civilized man impel him to 
work harder than a savage would work; they also force 
him to take more careful thought in the application of his 
energies. Hence the invention of new appliances for pro- 
duction and better methods of organizing and directing 
productive power. As a rule, the more numerous and 
complex the wants of an individual, the greater are his 
exertions and the higher the skill and intelligence with 
which his energies are directed. 

2. Human wants differ widely in elasticity, the 
wants for luxuries being more elastic than the 
wants for necessaries. 

Every want of man is capable of complete satisfaction. 
But the different wants vary widely in their insistency and 
in the ease with which they may be entirely satisfied. 
The want for bread, for instance, is extremely insistent, 
yet easily satisfied. I must have bread, but I would not 
care to have even a petty baker's entire supply. Such a 
want is known in economics as an inelastic one. The 
people of the United States require a fairly determinate 
quantity of wheat for food, and this quantity they will 
strive to secure even at great sacrifice. Much more than 
this, however, would not be wanted at all, unless of course 
it could be sold in other lands, or some use other than the 
supplying of food could be found for it. On the other 
hand, the want for some classes of things is very hard to 
satisfy at all, although it is not absolutely essential that 
the want be satisfied. I can get on very well without 
possessing paintings, but I should like to have all there 
are in the Louvre. The people of the United States may 
•live comfortably without having many art galleries, but 
it is almost inconceivable that they could have too many. 
Such wants, then, are elastic. 

As the examples given indicate, it is the wants for so- 
called necessaries that are inelastic; the wants for lux- 



26 INTRODUCTION TO ECONOMICS 

uries are elastic. Civilization tends to develop the wants 
for luxuries of all kinds. Hence, it may be said that the 
higher a people stands in the scale of civilization, the 
farther it is from the complete satisfaction of all its 
wants. 
3. When a want is satisfied by the consumption 
of a succession of similar goods, the satis- 
faction derived from the first consumed is 
greater than that derived from the second, and 
that derived from succeeding goods grows 
steadily less. This principle is known as the 
law of diminishing intensity of wants. 
Every man wants enough food to keep him alive; a 
quantity sufhcient for this purpose he desires intensely. 
An equal additional quantity will keep him in good condi- 
tion; this quantity he desires only less intensely. Give 
him more food; it may still please his palate, and satisfy 
a want. But a point is soon reached where the man 
wants no more food at all. 

So the want for a suit of clothes is hardly less insistent 
than the want for food enough for life. A second suit of 
clothes would be highly desired, even if of identical qual- 
ity, as it may be worn when the first is soaked with rain 
or otherwise out of condition for wear. A third suit of 
the same kind would not be desired very intensely; a 
fourth, or at any rate a fifth or sixth, would be a super- 
fluity. But if it is possible to vary the quality, the want 
becomes far more expansive. The social element becomes 
predominant; the man would dress at least as well as 
men in the social group to which he belongs, or of which 
he desires to become a member. Yet a point is eventually 
reached where neither increase in quantity nor improve- 
ment in quality is desired. 

It may then be stated, as one of the general laws of 
human nature, that each want is capable of varying de- 



UTILITY, VALUE, AND PRICE 27 

grees of satisfaction, that with each increase in the means 
of satisfaction the desire for additional means grows less, 
until a point is reached where want is no longer felt. 

4. The capacity of a good for satisfying wants is 
known as utility. 

Whatever satisfies a want is a good, in economic termi- 
nology. The power of a good to satisfy wants is utiHty. 
It is, of course, plain that nothing has utihty in this sense 
unless it is wanted. Utility is strictly parallel with want; 
human want for a certain object endows it with utility, 
and the degree of utility is measured by the degree of 
want. Before men knew the use of iron, iron ore was not 
wanted and had no utility at all; with every advance in 
the art of metallurgy, the utility of iron ore has increased. 
In the days of Marco Polo, the only utility that existed 
in the petroleum of Asia Minor arose from its use ''to 
anoint camels suffering from the mange"; now the prog- 
ress of science and industry has endowed the same 
material with a very high utility. 

The same object may have far greater utility under one 
set of circumstances than under another. A tree on a 
mountain side may have utility as it stands, derived, of 
course, from some prospective use. This utility may be 
called elementary utility. When the tree is felled and car- 
ried by a stream to a saw-mill, its utiHty is increased by 
mere change of place. This addition to the utility of the 
tree may be called place utility. A further increase in 
utility appears when the log is transformed into boards. 
This increase is known as form utility. If the boards 
should be kept in a lumber yard for ten years, very 
likely, on account of the failing supply of timber, their 
utility would be considerably increased. This increase 
may be called time utility. It is to be remembered, how- 
ever, that the foregoing terms do not represent different 
kinds of utility, but relate to the conditions under which 



28 INTRODUCTION TO ECONOMICS 

utility comes into existence. Utility is the single, uniform 
quality of want-satisfying power. 

Utility, it is to be borne in mind, is not identical with 
usefulness. Opium prepared for smoking, being ardently 
desired by the victims of the opium habit, has a very high 
utility, in the economic sense; but it is the reverse of 
useful. As a rule, whatever is useful has utihty, but 
there is no close correspondence between the degree of 
usefulness and the degree of utility. 

5. When a man acquires goods of the same kind 
one by one, the utility of the first good acquired 
exceeds that of the second, the utility of the 
second good exceeds that of the third, and so 
on, each successive good representing a smaller 
utility. This principle is known as the law 
of diminishing utility. 
We have seen that wants are capable of varying de- 
grees of satisfaction. As utility is strictly parallel with 
want, concrete goods, satisfying the different degrees of 
want, have different degrees of utility. Three bushels of 
wheat may supply me with bread enough to sustain life 
through a year; the utility of these three bushels — ■ 
supposing I have no other source of food supply — ■ is 
exceedingly great; I want them as I want life and all 
that life contains. It would not be easy to fix an esti- 
mate upon this amount of utility, but let us call it looo::^. 
Another three bushels would enable me to keep in fairly 
good physical condition; but their utility to me is evi- 
dently less; perhaps it would be loox. Another three 
bushels might mean overfeeding; yet some persons are 
desirous of being overfed; hence I may still desire these 
three bushels, and thus endow them with utility, which 
may possibly be measured by lox. With another three 
bushels I might feed a cat and a dog; it would give me 
pleasure to have these as pets; therefore I should desire 



UTILITY, VALUE, AND PRICE 29 

the additional supply of wheat, and it might represent a 
utility of 5x, An additional three bushels I could per- 
haps not use in any way giving me satisfaction. They 
would have no utility for me at all. 

Suppose that I find a remarkably beautiful seashell. 
As it seems desirable to me, it has utiHty to me. The 
amount of utiHty may equal loy. Another shell will not 
be so much of an acquisition, but I shall still desire it. 
Its utihty may perhaps be gy. Additional ones will give 
me less pleasure, but as the want for things of beauty is 
hard to satisfy, I may still experience a desire for a hun- 
dredth or a thousandth shell, and these would have some 
utility for me. There is, however, a point beyond which 
additional shells would merely cumber my premises; 
they would then have no utility for me. 

These examples assume, of course, that I do not un- 
dergo a change while I am acquiring these goods. If re- 
peated examination of the seashell inspires me with an 
increasing sense of its perfection of form, I may desire a 
second even more than I desired the first. Its utility will 
be greater than that of the first originally was, but not 
greater than the utility of a first shell would be in my 
present state. 

So one's first experience of classical music may be less 
enjoyable than his second experience of the same kind of 
music. He has, in the meantime, become a more cultured 
person. But assuming that no opportunity for develop- 
ment in taste is permitted, the pleasure derived from the 
first hour of listening to good music will be greater than 
that derived from a second successive hour of equally 
good music. The utility of the second hour of music is 
less. And so we may accept it as a general rule that the 
utility of a unit of any kind of good diminishes as the 
number of such units in one's possession increases. 



30 INTRODUCTION TO ECONOMICS 

6. The want-satisfying power of the least impor- 

tant unit of a commodity in one^s possession 
is termed the final or marginal utility of that 
commodity. 
In the foregoing examples it has been assumed that the 
quantity of the goods increased until no desire for further 
units existed. Most of the things which we desire are not 
to be had in superfluous quantities. Instead of having 
five units, each consisting of three bushels of wheat, let us 
assume that I have but three. The third unit would 
still have a utility of lox. As this is the utility of the 
last or final or marginal part of my supply, it is called 
final or marginal utility. Suppose that I have only ten 
seashells, and that the utility of the tenth is 53^. In eco- 
nomic language 5y is the final or marginal utility of sea- 
shells. Final utility, it is clear, is a very variable quan- 
tity; if the desire for a good increases, with no increase 
in the number of units of the good, final utility increases; 
if the desire remains the same, but the number of units 
of the good diminishes, final utihty again increases. In 
the first example, if the third unit of wheat were de- 
stroyed, the marginal utility of wheat would at once be- 
come lOOX. 

Conversely, marginal utility diminishes with decrease 
in want or increase in number of units. I might tire of 
collecting seashells, or the waves might wash up a wagon- 
load of them. In either case the marginal utihty would 
shrink — perhaps to zero. 

7. In effect, the importance of any unit of a com- 

modity is determined by the want-satisfying 
power of the marginal unit. The importance 
of a unit, thus determined, is termed its effective 
utility. 
But does any man really arrange his wheat or other 
goods in series of units and say to himself: "This unit is 



UTILITY, VALUE, AND PRICE 31 

worth looox; without it I should starve; this unit is 
worth looic, as my comfort and strength depend upon it; 
this unit is worth ^x, for if I did not have it I should be 
compelled to do without my pets"? Not at all; the dif- 
ferent units are just alike, and one is thought of as just as 
desirable as another. For practical purposes, the utiUty 
of one unit is the same as that of another. Let us sup- 
pose that there are four units of wheat, and that the last 
has a utility of 5X. What is lost if any one of the four 
units is lost? Simply ^x. What sacrifice would one make 
to prevent the loss of any unit, even the one which would 
have been used to sustain life, and by itself would be 
worth looox.? A sacrifice not greater than 5^. For if 
any other unit is lost, the least important one will be sub- 
stituted for it, and the effective loss will be properly 
placed at 5:^. 

The utility of the last and least important unit, then, 
exercises an important influence in determining what util- 
ity one will in effect ascribe to any unit. For practical 
purposes the utility of any unit is exactly equal to that 
of the least important one. The utility of a unit, thus 
measured by that of the least important one, is called 
''effective utility." 

If the total number of units of a good is so great that 
the last one has no utility, the good has no effective util- 
ity at all. No one will do anything to prevent the destruc- 
tion of part of his supply; no one will give anything to in- 
crease his supply. Thus water, although a single gallon 
would have indefinitely great utility if this were the only 
gallon available, is in most places so abundant that the 
last units of the supply have no utility. Therefore no 
unit has effective utility. 



32 INTRODUCTION TO ECONOMICS 

8. A knowledge of the comparative effective utilities 
of different goods is essential to the rational 
application of means for the production or 
acquisition of goods. 

Almost every one who is about to engage in the produc- 
tion of wealth has several options as to the kinds of goods 
he may produce and as to the qualities or grades of each 
kind. A farmer may produce wheat or corn, cattle or 
hogs; he may produce a hard variety of wheat or a soft 
one; he may produce thoroughbred stock or grade stock. 
Every man who is at the point of making a purchase has 
numerous options as to the goods upon which he is to 
spend his money. Some options, naturally, offer greater 
advantages than others. 

Suppose that a farmer can produce, with the expendi- 
ture of one day's labor, two bushels of potatoes or one 
bushel of wheat. Should he spend his time in producing 
wheat, or potatoes, or both? If the effective utility of 
two bushels of potatoes is greater than that of a bushel of 
wheat, the rational thing for him to do is to produce more 
potatoes and to spend less time producing wheat. In ac- 
cordance with the law of diminishing utility, the effective 
utility of potatoes will decline as their quantity increases; 
at the same time, that of wheat will increase, as our ex- 
ample assumes that labor formerly occupied in wheat pro- 
duction is diverted to the raising of potatoes. A point 
will probably be reached where a day's labor will produce 
as much utility in one branch of agriculture as in the 
other; and until this point is reached, the cultivator has it 
in his power to increase his welfare simply by making a 
more rational distribution of his labor. 

But before one can rationally distribute his labor or 
other resources, he must have a definite notion of the 
relative effective utilities of goods. He must measure the 
utility of one — the degree in which it seems desirable to 



UTILITY, VALUE, AND PRICE ^^ 

him — in terms of the utility of another; or he must 
measure them all by a common standard. And this, of 
course, is easy to do. Think of any two objects. Which 
seems the more desirable? That one has the greater 
utiUty for you. How far would you walk in order to get 
good No. I? If you would walk twice as far to get good 
No. 2, the latter has, for you, twice the effective utiHty of 
the former. Any good, or any sacrifice, may serve us 
as a standard for measuring the comparative utihties of 
goods. Under existing economic conditions, of course, 
the standard which most readily occurs to one is money. 
If one wishes to compare the utilities of wheat and pota- 
toes, he naturally considers how much money he would 
give for a bushel of either. 

9. The utility of a good, measured by some stand- 
ard, either of utility or sacrifice, is personal 
value. Personal value varies from individual 
to individual, and is constantly fluctuating. 
Now, the effective utility of a commodity, compared 
with that of some other commodity, or compared with 
some sacrifice which serves as a standard, is personal or 
"subjective" value. Value in this sense of the term is 
effective utility measured. And as effective utility is 
constantly fluctuating with changes in the amount of a 
good, or in the desire for it, personal value is also always 
fluctuating. 

We often hear of the '^real" value of a thing, or of the 
''intrinsic" value, as if there were some kind of value resi- 
dent in a thing apart from man's desire for it. Thus a 
painting, picked up at an auction for say, $ioo, may be- 
pronounced by an expert ''intrinsically" worth $500. 
That is the expert's judgment of the market value of the 
painting under more usual conditions of sale. A stock- 
broker often assures his clients that a particular security, 
to be had, say, at 75, is worth "intrinsically" 100. That 



34 INTRODUCTION TO ECONOMICS 

is his judgment of the prospective income yield and the 
price the investment market will at some future time 
place upon it. These "intrinsic" values, then, are noth- 
ing but assumptions as to the personal values that will 
emerge under different conditions and at a future 
time. 

Values will naturally be different for different persons. 
What is the value of my grandfather's watch? To me, it 
may be equal to that of $1000. Perhaps you would not 
give $10 for such an antiquated timepiece. In less ex- 
treme degree the same thing holds of every good. Some 
will place a high value upon an object; others a low value; 
and the one is as properly the true or intrinsic value as 
the other. 

But is there not a certain scale of values in which most 
persons agree, and has not this general value a claim to 
the title "true value"? There is indeed something Hke 
a scale of values established, as it were, by common con- 
sent; and the economic activities of each are, in effect, 
directed toward making his own scale of values conform 
to that of society. How this social scale of values arises 
out of the purely personal values just described, it will 
be our next task to consider. It is of course self-evident 
that the social value does so arise. One cannot conceive 
of society as establishing values and imparting them to 
individuals. 

10. Personal values are in some measure social- 
ized through imitation. 

Utility, as we have seen, is a quality with which an ob- 
ject is endowed by virtue of a human want. This want 
may arise out of personal or out of social need. If a par- 
ticular social need should disappear or change, certain 
of our wants would disappear or change. Certain classes 
of goods, destined to satisfy such wants, would lose their 
value, or undergo some change in it. There was a time 



UTILITY, VALUE, AND PRICE 35 

when gentlemen clipped their own hair and covered their 
heads with wigs. To move in polite society, one had to 
follow this, as other fashions. Hence there was a want 
for wigs, and these were endowed with effective utiHty 
and value accordingly. As the wearing of one's own hair 
came into vogue, this particular kind of wig ceased to 
have either utiHty or value. Now it is clear enough that 
the great majority of those who followed the earHer fash- 
ion could have had no personal need nor want for a wig. 
They derived the want from their associates. The cus- 
tom, I suppose, originated with some bald-headed prince 
who really needed a wig. And so it was transmitted 
from the court to the gentry, and persisted long after 
the reason for its existence had disappeared. The value 
of wigs thus arose from a personal need; it attained 
vogue through imitation, and, by a similar process, faded 
out and disappeared. 

Suppose that I attend an auction of the effects of an 
eccentric gentleman, who has led a solitary Hfe collecting 
odds and ends of all kinds, among them some things of 
value. I find a painting that pleases me. Say that I 
know nothing of art, and that all the painting represents 
to me is a group of dull, brutish persons, making un- 
necessarily hard work out of some simple agricultural opera- 
tion. What is its value to me? It would be difficult to 
say ; certainly in my own mind the value is something very 
tentative. But finding that the picture can be had for no 
great sum, I resolve to buy it. I hang my acquisition in 
an inconspicuous place, for I am not sure whether I 
should be proud of it or ashamed of it. A friend who 
knows something of art calls on me. Perhaps he takes 
merely a glance at the picture and says nothing. Its 
value to me shrinks to zero. But if he cries enthusi- 
astically, "Ah! a Millet!" immediately its value to me 
expands in an extraordinary fashion; what had been 



36 INTRODUCTION TO ECONOMICS 

scarcely a valuable object at all becomes a priceless 
treasure. 

Here then is one reason why values for different per- 
sons tend to conform to the same scale. If I find that 
most of my friends think that a riding horse is dear at 
$300, I think so, too, although I might get more satis- 
faction out of the horse than they. Value is thus in 
large measure a matter of imitation. But before one can 
imitate, there must be something original to serve as a 
center of imitation; and in the matter of values, this 
must be the original personal value of some, arising out 
of effective utility to them. 

Moreover, though imitation brings about a certain uni- 
formity in the scales of values of different persons, it 
can not of itself make them absolutely alike. If most 
of my friends think that a particular horse is worth 
$200, I certainly would not value it at $300, unless in- 
deed I am a connoisseur in horseflesh and my friends 
are not. But I may think the horse is cheap at $200, 
while my friends may think it is dear. And this shows 
that in spite of all tendency to conform, there is in my 
scale of values some part that is peculiarly my own. 

11. Personal values are profoundly influenced by 
the art of salesmanship. 

Because personal values are in most cases uncertain 
and fluctuating, readily susceptible to suggestion and imi- 
tation, it is always possible for a shrewd salesman to 
manipulate them„ to his own advantage. I enter a shop 
with the fixed purpose of buying a hat, and nothing 
else. I have a definite idea of the kind of hat I want, 
and the price I am willing to pay for it. Do I come 
away from the shop with just that hat and nothing else? 
Not unless I am of unusually decisive character, or the 
salesman weak in his art. In the ordinary case the sales- 
man, by a gesture or tone of depreciation so slight that 



UTILITY, VALUE, AND PRICE , 37 

I feel it rather than observe it consciously, raises a doubt 
in my mind whether the hat I want is really the best 
bargain I can make. Subtly he leads me to transfer my 
interest to another hat, more expensive or at all events 
affording him a larger margin of profit. Nor does he 
let me go with the hat, but manages to excite in me 
values I had not been conscious of, adhering to gloves, 
ties, or perhaps even a cane. When I entered the shop 
none of these things seemed for my purposes worth the 
money they cost. When I leave it some of them, at 
any rate, have assumed a higher value in proportion to 
money; and the proof of it is that I have parted with 
my money in their acquisition. 

Modern salesmanship, in aU its ramifications, is a 
mighty force playing ceaselessly upon all of us. Con- 
sider how the feehng has been built up in most of us 
that capacity for floating is an extremely useful property 
in a soap. A number of years ago the American people 
would not consume enough raisins to make the California 
grape growers prosperous. They organized an advertis- 
ing campaign the object of which was to make us all 
place a higher personal value on raisins as food. The 
result was a great increase in the consumption of raisins, 
and at increased prices. There are many articles in 
general use whose values have been built up almost 
wholly in this way. More money may have been spent 
in attracting the attention of the consumer and manipu- 
lating his sense of values, than in producing the articles 
and in transporting them to the dealer's shelves. 

12. The most effective force making for socializa- 
tion of values is exchange. 

So long as men lived in self-sufficing groups, producing 
whatever they needed for their own use, there was no 
other force than imitation which could make the personal 
valuations of one group correspond with those of another. 



38 INTRODUCTION TO ECONOMICS 

But in an exchange economy there is a much more po- 
tent force making for the sociaHzation of values. 

Suppose that two farmers, with adjoining fields, both 
grow potatoes and wheat, and suppose that they are so 
far from a market that they can exchange their products 
only with each other. Farmer A may consider that a 
bushel of wheat is worth two bushels of potatoes; 
Farmer B may consider a bushel of potatoes worth two 
bushels of wheat. 

Assuming such a divergence in personal valuations the 
natural result will be, not that they will debate the 
relative justice of their views of value, but that they 
will trade. Farmer A can afford to offer Farmer B two 
bushels of potatoes for a bushel of wheat; Farmer B 
can afford to accept even a half bushel of potatoes for 
a bushel of wheat. Exactly how much A will at first 
offer, we cannot say, nor is that of much importance. 
What is certain is that he can, and probably will, offer 
terms that will be acceptable to B, and some bushels 
will be exchanged. 

Now, as A parts with some of his potatoes, the effective 
utility, and with it the value, of potatoes to him in- 
creases. As he gets more wheat, the effective utility of 
wheat declines. And the reverse will be the case with B, 
who is increasing his stock of potatoes and diminishing 
his stock of wheat. It may still be worth while for the 
two farmers to exchange more bushels; but it is not so 
much worth while as it was at first. In the end, ex- 
change must cease, for each will value wheat in terms 
of potatoes exactly as the other does. 

Perhaps Farmer A has land that is very well adapted 
to potato production, while Farmer B's land is best fitted 
for the growing of wheat. In another year A will have 
a superfluity of potatoes and B of wheat, and the process 
of exchange will again be necessary to equalize values. 



UTILITY, VALUE, AND PRICE 39 

So in a developed economic system the value of wheat 
in regions where it is produced tends continually to fall 
below the value of it in regions where little wheat is 
grown; and this it is that keeps up a constant exchange 
between distant regions. And this constant exchange, in 
turn, tends to eliminate the discrepancies in values. 

Returning to the case of the two neighbors, perhaps A 
has a cow which he does not care to keep, but which B 
would hke to have; while the latter has a harrow which 
he does not need, but the former could well use. Possibly 
A values the cow at twenty bushels of wheat and the 
harrow at thirty; while B values the cow at thirty 
bushels of wheat and the harrow at twenty. Here is 
a good opportunity for a trade. Either one might give 
the other a certain number of bushels of wheat "to 
boot," in order to bring about the trade. At what 
terms will the exchange be made? We cannot tell. Nor 
will the exchange, at whatever terms, affect the relative 
values placed upon cows and harrows by either party 
to the exchange. It would be different if more cows 
and harrows were to be exchanged. In that case the 
scales of values of the two exchangers would tend to 
uniformity, as was the case with the potatoes and wheat. 
But very likely no further exchanges are to be made. 
So I may be able to buy for $25 a coat that I would 
regard as cheap at $50. Another coat at $25, however, 
might not seem worth more to me than $20; accordingly, 
I refrain from buying it. Hence the coat which I do 
buy retains a personal value for me in excess of the 
value placed upon it by the seller. It is a value that 
as a whole refuses to be socialized. A similar state of 
affairs exists wherever one buys single goods, not quan- 
tities of like units, as in the case of wheat. 



40 INTRODUCTION TO ECONOMICS 

13. Personal values may he mere refleetions from 

social values. Such personal values may he 
called personal or subjective exchange values. 

In the examples employed in the last section it was 
assumed that both parties to the exchange had personal 
values, arising out of their own wants, for both com- 
modities exchanged. This may have been the usual case 
under primitive conditions; but now, when we produce 
almost exclusively for sale, the seller of a commodity 
must fix a personal value in some other way. Say that 
I am a dealer in women's shoes. For my personal use 
they have no value whatsoever. Yet when a prospective 
customer appears, I have just as definite a value, below 
which I would not sell the shoes, as I should have if I 
were trading off a pair of shoes that I might use myself. 
Whence do I derive this value? I know that if I do not 
sell shoes to this particular buyer I shall probably be able 
to sell them to some one else. And I will take no less for 
them than I think some one else will pay. If experience 
shows me that few persons will pay the price, I must 
alter my personal value, or the fashions will change, and 
I shall have a stock of unsalable leather on my hands. 

Now it must be plain that this kind of personal value 
is entirely a secondary phenomenon. It is derived from 
the estimate of other men's personal values, arising from 
personal needs. It has its importance; but it does not 
explain the values that are actually placed upon goods. This 
explanation lies in the facts of direct personal valuation. 

14. Value expressed in terms of money is known 

in economics as price. 
In one's personal estimate of values one may employ 
as a standard of measurement any object having effective 
utility. The farmer may value a horse in terms of wheat 
or cotton; the ranchman in terms of cattle; the fisher- 
man in terms of fish. The difficulty with such estimates 



UTILITY, VALUE, AND PRICE 41 

is that they are not sufficiently intelligible to other per- 
sons. A traveler in the Orient writes that a certain 
rajah places the value of an elephant at 2000 yards of 
Japanese silk. Do you know whether the elephant is 
dear or cheap? If the valuation were made in terms of 
silver or gold, we should all have a fairly definite idea 
of the value placed upon the elephant, as we are daily 
using these metals and estimating their importance. In 
practice values are usually expressed in terms of silver 
or gold money. For convenience, economists use the 
term ^^price" as the equivalent of money value. There 
are personal prices and social prices, just as there are 
personal and social values. Social prices are practi- 
cally determined by the action of buyers and sellers, 
and as these commonly meet in a market, social price 
is called market price. 

15. Market prices tend to a uniformity, and cor- 
respond with the personal prices of those-y 
who are least eager to buy or to sell but who 
nevertheless succeed in buying or selling. 

Personal values, as we have seen, naturally vary widely 
with different individuals. We need not believe that 
any two persons would afhx exactly the same money 
valuation upon a particular horse. One man might value 
the horse, for his personal use, at $500; another at $50. 
Yet we find that for a certain grade of horses there is 
something like a uniform price. Perhaps this price is 
$250. In such case the personal values of $50 and $500 
are both ignored. They have no influence upon the price 
actually set. 

Personally I may abhor the idea of flying. If I were 
to place a value upon aeroplanes for my own use, it 
would be far less than nothing. Clearly my personal 
value of aeroplanes has nothing to do with their price, 
which for a given grade may be $5000. If I had a mild 



42 INTRODUCTION TO ECONOMICS 

interest in this form of sport I might value an aero- 
plane at $1000; yet I should not influence their price. 
Were I so passionately fond of flying, and so plentifully 
provided with money, as to value an aeroplane at $100,- 
000, this valuation would nevertheless be incapable of 
raising the price of aeroplanes much, if any, above $5000. 
It is clear, then, that some personal values count, and 
some do not, in the determination of prices as they are 
■fixed in the market. 

To show just what it is that determines what personal 
values count in fixing market prices, we may employ a 
somewhat artificial example which is the common prop- 
erty of modern text-books in economics. Let us imagine 
a horse market in which there are six persons with horses 
to sell, and six persons each of whom would like to buy 
a horse. We will assume that the horses are as alike as 
peas, so that each buyer would as willingly have one as 
another. Of course each buyer desires to buy as cheaply 
as possible, and each seller desires the highest possible 
price for his horse. Each buyer has in his own mind 
a top price — the most he would pay under any circum- 
stances — and each seller has a bottom price, below 
which he would absolutely refuse to go. Being rational 
men, the buyers carefully refrain from letting their top 
prices be known; and in the same way the sellers keep 
their lowest prices a close secret. We shall assume the 
fiction writer's omniscience, and set down the top and 
bottom prices of the buyers and sellers respectively, as 
follows : — 



Buyers 


Sellers 


A $100 


M I90 


B 90 


N 80 


C 80 


70 


D 70 


P 60 


E 60 


Q 50 


F 50 


R 40 



UTILITY, VALUE, AND PRICE 43 

How many horses will be sold, and at what price? 
Of course, if each of the buyers in the first column were 
shut up in a stall with the seller in the opposite column, 
all the horses would be sold, and at different prices. 
But we are assuming that all are in an open yard, and 
hear one another's bids and offers. Under these circum- 
stances no buyer will pay more than another, nor will 
one seller take less for his horse than another. What 
price will actually be fixed can be seen by following out 
in detail the probable action, of these buyers and sellers. 

Suppose A, a buyer, offers $40 as his first bid. R 
could afford to take it; but as any of the other five buy- 
ers would be glad to get a horse at that price, they each 
offer a little more than $40. Competition for this horse 
goes on until the price is raised to $50. At this point 
two horses may be had; but there are six competing 
buyers, and the price goes higher. Thereupon F, who 
will pay no more than $50, drops out. He can exercise 
no more influence in determining the price of these 
horses than I can in determining the price of aeroplanes. 
Bidding goes on, and the price is forced up to $60. 
Three horses are to be had at this price; but as there 
are still five buyers the price goes above $60, and E 
drops out. At last the price reaches $70. There are 
now four sellers wilHng to part with their horses at this 
price; and four buyers willing to pay the price. Imagine 
that bidding goes on, and the price rises to $71. D 
would then drop out, and four horses would be offered, 
with only three buyers. Any one of the four sellers 
would rather sell at $70 than have his horse unsold; 
bidding among the sellers, therefore, forces the price back 
to $70. Under the conditions this price represents an 
equilibrium between the values of the buyers and those 
of the sellers. 

Let us imagine, however, that before the sale is ac- 



44 INTRODUCTION TO ECONOMICS 

tually effected, another buyer, with a maximum valuation 
of $iio, appears. The price will then be forced above 
$70, and D will drop out. It will not reach $80, however, 
for then five sellers would compete to meet the needs 
of four buyers. The actual price will be fixed somewhere 
between $70 and $80. If an additional seller, with a valu- 
ation of $30, were to appear, the number of buyers re- 
maining the same, the price would drop below $70, but 
not quite to $60. 

The seller who is least desirous of selling, but who 
nevertheless effects a sale, is known as the marginal 
seller. The buyer who is least eager to buy, but yet 
succeeds in buying, is known as the marginal buyer. 
16. Demand is the volume of purchases of a com- 
modity that would be made at a given price. 
Supply is the volume of sales that would be 
made at a given price. Market price tends 
to fix itself at a point where demand and 
supply thus defined are equal. 
Every person who reads widely in economic literature, 
frequently encounters the statement that market prices 
are determined by demand and supply. It is therefore 
worth while to ascertain exactly what these terms mean. 
Demand is clearly not synonymous with want or desire. 
We may imagine a Hindoo grain dealer closing up his 
shop because there is no demand for grain, although he 
may be besieged by an army of starving people. Desire 
must be supported by purchasing power before it be- 
comes demand. Supply does not mean the existing stock 
of a commodity. There may be a shortage in the wheat 
supply because those who have wheat are holding it 
for higher prices. The owner of a commodity must be 
willing to sell before the stock in his possession becomes 
part of the supply. It is evident that in most instances 
the lower the price of a commodity, the greater will be 



UTILITY, VALUE, AND PRICE 45 

the demand for it and the less will be the supply, and 
vice versa. The demand for wheat at ten cents a bushel 
would be enormous, the supply at that price would 
dwindle to practically nothing. There must be some 
price for each commodity that will exactly equalize the 
volume of demand with that of supply. This price is 
the one that will prevail in the market. 

At a given time the aggregate demand for wheat at 
$2 a bushel may extend to one million bushels; but 
the sellers of wheat may be willing to place on the mar- 
ket two million bushels at prices ranging from one dollar 
up to two. Manifestly $2 a bushel cannot be the price set 
by the ijtiarket, for the owners of the second million bushels, 
not finding purchasers, will offer it for less. At a lower 
price, some sellers will drop out, and some additional 
purchasers will appear. At $1.50 a bushel, perhaps fif- 
teen hundred thousand bushels will be offered, and the 
same amount taken. Then $1.50 is the price that will 
actually be set. 

Those buyers whose personal valuations are the lowest, 
and who would be ready to drop out if the price rose, 
are the ones who at any particular time determine the 
volume of the demand. Those sellers whose personal 
values are highest, and who are ready to drop out if 
the price falls, determine, for the time being, the volume 
of the supply. The principle that the price is fixed 
at a point which equalizes demand and supply is there- 
fore tantamount to the principle, given in section 15, 
that price corresponds with the personal valuations of 
those who are least eager to buy or to sell, or the mar- 
ginal buyers or sellers. 

17. A particular set of marginal buyers and sellers 
control prices only for a brief time. 

While it is the buyers and sellers who are just ready 
to drop out with changes in price — the marginal buyers 



46 INTRODUCTION TO ECONOMICS 

and sellers — who at a given time hold the price where 
it is, price changes may take place in spite of them, 
through changes in the wants of purchasers, or through 
the appearance of new sellers. The introduction of the 
automobile resulted in a new demand for gasolene, and 
as a consequence the price rose, eliminating the pur- 
chasers who had before been in a price-determining po- 
sition. If alcohol came to be produced cheaply in vast 
quantities and ways were found for substituting it suc- 
cessfully for gasolene for the same purpose, the price 
'of gasolene would fall, and a new set of purchasers, who 
formerly had nothing to do with fixing its price, as they 
,did not desire it enough to buy it, would come to occupy 
the position of controllers of the price. 

Under existing conditions we do not find ourselves in 
the presence of unpriced goods upon which a price is to 
be placed. Everything that one wishes to buy already 
bears a price; one accepts the price, or refrains from 
purchasing. I compare my personal value of anything — 
say a hat — ^with the value of the commodity in the 
market. If I decide that a hat is worth more than $5 
to me, I purchase it if it is to be had at that price. 
As I part with some of my money, each dollar I have is 
worth more to me; and hats are worth less. Thus I 
make my personal value approximate that of the market. 
If I am a seller of hats, and I find that $5 is worth more 
to me than a hat, I wilKngly part with the hat at that price. 
As I have more dollars, one is worth less to me; having 
fewer hats, I am not so eager to part with one. Thus by 
buying and selling one makes his personal values con- 
form more nearly to that of the market. At the same 
time, by taking a hat from the seller, I reduce by a trifle 
the number to be sold to other purchasers; I make the 
hat sellers less eager to sell, and contribute of my puny 
strength to draw up the general level of value of hats to 



UTILITY, VALUE, AND PRICE 47 

my own personal value. So all of us who are purchasers 
are joining our efforts to raise prices to a high level, al- 
though what we desire is low prices; and all of us who 
are sellers are exerting our combined strength to pull 
them down, although our chief desire is high prices. 
Those of us who are least eager to buy or to sell exer- 
cise an equalizing function; when the buyers' side pre- 
vails, and prices are rising, the least willing buyers drop 
out; and similarly with the least willing sellers, when 
the sellers succeed in pulling prices down. 

18. Summary. 

Progress in civilization is attended by an ever-increas- 
ing number of wants. , Of these, some are inelastic: 
though often very insistent, they can easily be completely 
satisfied. Other wants are elastic. Complete satisfaction 
of elastic wants is difficult. Wants of the latter class 
evince the greater tendency toward development with the 
progress of civilization. Wants of both classes admit of 
different degrees of satisfaction; in the case of every 
want successive increments in the means of satisfaction 
are desired with diminishing intensity. 

Utihty is want-satisfying power. Successive increments 
of any good diminish in utiHty as the want endowing 
them with utility diminishes in intensity. The least im- 
portant of a number of units of a given good is known 
as the marginal unit; its utility is termed marginal or 
final utility. In effect, the utility of any unit of a given 
good is no greater than that of the marginal unit. The 
utility of any unit, thus reduced to terms of that of the 
marginal unit, is effective utiHty. 

In order that a man may direct his economic activities 
to the best advantage, he must often compare the effec- 
tive utility of one commodity or service with that of 
another. The effective utility of one good thus measured 
by that of another is personal value. Personal values 



48 INTRODUCTION TO ECONOMICS 

vary from individual to individual; they may, however, 
be reduced to approximate uniformity through imitation 
or through exchange. When all the personal values in 
a social group have been reduced to uniformity, social 
values emerge. These values, expressed in terms of 
money, are prices. 

In a market prices are fixed at a level corresponding 
with the personal valuations of those actual buyers who 
are least eager to buy and those sellers who are least 
eager to sell. From another viewpoint, it will be seen 
that prices are established when the amount offered for 
sale at a given price just equals the amount sought by 
purchasers at that price, or, in other words, where demand 
and supply are equal. 



CHAPTER III 
NORMAL COMPETITIVE PRICE 

1. The market price of the most important com- 
modities is subject to frequent fluctuations. 

Since prices depend upon the valuations of the mar- 
ginal buyers and sellers, or, what amounts to the same 
thing, upon demand and supply — factors that are con- 
stantly changing — we should naturally expect prices to 
fluctuate. That they do fluctuate is easily proved, either 
by our daily experience in buying and selling, or by an 
examination of price statistics. In the period from 191 5 
to 192 1 the average annual price of wheat rose from 
I1.08 per bushel in 1915 to $2.32 in 1920 and declined 
to $1.49 in 1921. Corn rose from 66 cents in 1915 
to $1.45 in 1919 and declined to 67 cents in 192 1. 
Cotton rose from 6.6 cents in 1915 to 35.9 cents in 
1920 and declined to 11.5 cents in 1921. The war and 
its consequences had much to Jo with these remarkable 
price fluctuations. But even in time of peace agricul- 
tural prices vary greatly from year to year, from month 
to month, and even from day to day. 

We are, indeed, familiar with a large class of commodi- 
ties the price of which never varies. Postage stamps 
are always sold at uniform prices. Many patented ar- 
ticles, especially goods for personal use, and most copy- 
righted books, are sold at unvarying prices. For long 
periods steel rails are quoted at unvarying figures. The 
explanation of such steadiness in price is always the 
same — monopoly, in one form or another. Where there 

49 



50 , INTRODUCTION TO ECONOMICS 

is but one seller, and that seller resolutely refuses to 
change his prices, there can, of course, be no price 
fluctuations. We shall postpone discussion of monopoly 
prices to the following chapter; in the present we are 
concerned with the laws governing prices in the com- 
petitive field. 

2. The prices of perishable commodities fluctuate 

more widely than do the prices of those com- 
modities that are relatively imperishable. 
Spectacular changes are not common in the prices of 
durable commodities whose production can readily be in- 
creased or diminished at will. The price of pig iron, 
copper bars, staple cotton or leather goods does not 
fluctuate widely in brief periods of time. These goods 
will keep. If there is no demand for them to-day, they 
may be held over for weeks or months or years. The 
producer will hold them for the recovery of demand, re- 
ducing his current production if necessary. If it happens 
that they are forced to unusually low prices, buyers can 
afford to lay in stocks, and their increased buying works 
to send prices up toward the usual level. The prices of 
such commodities as strawberries, fresh vegetables, and 
fresh fish may easily advance or decline loo per cent, in 
a single week. With progress in methods of preserving 
such commodities, the range of price fluctuations is re- 
duced. We do not buy perishable commodities at such 
low prices, nor at such high prices, as were known before 
refrigeration came into common use. 

3. The range of price fluctuations grows less with 

improvements in transportation and the exten- 
sion of the market. 
In the early part of the nineteenth century England, 
through the policy of levying heavy duties on imported 
wheat, forced her population to rely almost exclusively 
upon the domestic supplies of grain. As a consequence 



NORMAL COMPETITIVE PRICE , 51 

of this policy a good season meant very low prices, a 
bad season very high ones. In 181 2 the price of wheat 
rose to $3.84 per bushel; in 1822 the price was $1.35. 
To-day such a range of wheat prices is unknown in Eng- 
land except when ocean transportation is disorganized 
by war. Wheat is imported from all quarters of the 
globe, and it is impossible that all the world should have 
a bad season at one time. If the American crop is short, 
it is highly probable that the crop of India or Argentina 
will be exceptionally heavy. 

Improvements in railway transportation have made 
possible the carriage of perishable commodities over great 
distances. Fresh fish from the Columbia river on our 
northwest coast are now carried to England when the 
prices in the English market are high enough to justify 
the expense of transportation. This keeps the local price 
of fish from falling so low as it otherwise would, when 
the catch is heavy, and keeps the English price from 
rising so high as it otherwise would when the North Sea 
fisheries yield a short supply. 

We are safe in saying that modern improvements in 
transportation and market organization tend to elimi- 
nate sharp fluctuations, limited to a small area, and to 
substitute more moderate fluctuations, extending over 
wide areas. 

4. Competitive prices tend toward a theoretical 
level which may he called the normal, since 
every deviation from this level is followed by 
a reaction. 

At times market prices rest at a level that every 
one knows is too high or too low to be maintained for 
any long period. Such prices we naturally regard as 
abnormal. A certain fabric comes into vogue; every- 
body must have it, and, as there is not an indefinite 
amount of it, the price rises. Perhaps it was worth $1 



52 INTRODUCTION TO ECONOMICS 

a yard before fashion touched it with its magic wand; 
the price may easily become $5. Now, is this price one 
that is likely to continue — even supposing that the 
fashion should be transformed into a custom, and the 
enlarged demand for the fabric should thus become per- 
manent? Would it be safe for one to buy large stocks 
of this cloth, with the expectation of selling them at 
$5 a yard? Would it be wise for one to put up a mill 
for the manufacture of this kind of goods, with the 
expectation that the high price would continue? There 
are conceivable conditions under which one might pru- 
dently do these things; but in most cases this would be 
very bad business. Most probably, the price would sink 
again toward the $1 mark. In all Hkelihood $1 is about 
what that fabric will sell for in the long run. 

If for any reason the price of wheat rises to $3 a 
bushel, we can predict with absolute certainty that the 
number of sellers will go on increasing until the price 
comes down; $3 for wheat is therefore an abnormal, or 
unnatural, price. On the other hand, if the price falls 
to fifty cents a bushel, we may be certain that in time 
sellers will drop out, and the price will rise. Fifty cents 
is an abnormal price, just as $3 is. Between the two 
prices must somewhere be one that is normal or natural. 
The market price will be constantly rising above or 
falKng below it; yet there will always be an increase in 
selhng when the price is above the normal, and a dimi- 
nution in the number of sales when the price is below the 
normal; consequently the price will fluctuate about this 
point, never remaining long much above or much below it. 

So it is with a large proportion of the commodities 
sold on the market. Their prices may at any time 
double; but in all probability this is a transient phenom- 
enon. If anything is sold at an extremely low price — a 
price that has rarely been known before — probably this 



NORMAL COMPETITIVE PRICE , 53 

also is a transient phenomenon. And just as it would be 
bad business to buy large stocks, or build factories, in 
anticipation of the continuance of excessively high prices, 
so it would be folly to quit a business, or sell out all one's 
stock, because of excessively low prices. The business 
man who is most likely to succeed is the one who has 
a due appreciation of normal price and who directs his 
business, so far as it is concerned with a more or less 
distant future, in accordance with the laws of normal 
price. Accordingly great practical importance attaches 
to normal price. And in so far as it determines the direc- 
tion of the productive forces of society, it is of the high- 
est importance to the student of economics, as well as 
to the man of affairs. This is true even though actual 
prices may at any given time be above or below the 
normal, and may perhaps never remain for an appre- 
ciable time at precisely the normal level. 

5. The forces which cause prices to hover about 
a normal level originate in the field of 
production or supply. 

Prices, we have seen, rise or fall in consequence of 
changes either in demand or in supply. The most violent 
fluctuations in price are, as a rule, due to changes in 
demand. Consider the fall in price, in the early autumn, 
of summer clothing. Increase in supply has nothing to 
do with this price change; decrease in demand is the 
sole explanation. Compare the price of a striking style 
of women's hats, at the height of their popularity, with 
their price when another style of hat gains the ascend- 
ency. The forces of demand originate, in large part, in 
caprice, individual and social. Were prices determined 
solely by these forces it would be vain to search for a 
law of normal price. 

The forces governing supply, on the other hand, admit 
of a reasonable degree of calculation. Supply is con- 



54 



INTRODUCTION TO ECONOMICS 



trolled, in a measure, by chance, as in the case of the 
products of the soil, which may be abundant or scarce 
according to the season. Far more important, in the 
control of supply, are the decisions of producers, and 
these decisions are usually the result of calculations, not 
caprice. A man raises hogs or peas or even roses, not 
because it pleases him to do so, but because he thinks 
it ''pays." 

The supply of most commodities may be increased or 
diminished at the will of the producers. Many producers 
are in a position to increase their output by slightly en- 
larging their working force, or by running overtime. 
Some producers are engaged in the manufacture of a 
number of different commodities, or of grades of one kind 
of commodity. By discontinuing the production of some 
of these and concentrating their energies on a single one, 
they exert an influence upon supply. Moreover, there 
are always some persons who are in doubt whether or not 
they shall enter upon a certain line of production; still 
others, now engaged in that line of production, are in 
doubt whether or not they shall go out of business. 

When the price of a given commodity is very high, 
factories producing that commodity run on full time, or 
overtime; factories that would otherwise have produced 
several other commodities turn all their energies in this 
direction; manufactur'ers who were in doubt as to 
whether or not they should go on producing, find their 
doubt stilled; and new producers are lured into the in- 
dustry. All this makes for an increased supply and a 
falling price. How long will the expansion of business 
continue? 

6. Normal price is that price which just covers 
the cost of production. 

The two factors determining the business conduct of a 
producer are price and cost of production. In the cost of 



NORMAL COMPETITIVE PRICE 55 

production are included the value of materials used and 
the wear and tear and general depreciation of machinery, 
buildings, lands; interest on all capital used, whether 
borrowed or owned by the producer; wages of all labor, 
whether hired or that of the producer himself; premiums 
to insurance companies for the assumption of the risk of 
destruction: of buildings and stock, or an equivalent re- 
turn for risk if borne by the producer himself; taxes, 
water rates, etc. If the price of a commodity exceeds its 
cost, including in the term all the above-named elements, 
the supply of the commodity can be profitably increased. 
If the price just equals cost, there is no sufficient reason 
for either increasing or diminishing the supply. If the 
price is less than cost, the supply will diminish. 

Suppose that it costs an average manufacturer $1 to 
produce a yard of woolen cloth. If he can sell it for $1, 
he will probably go on producing about as much this 
month as he did last. For this price enables him to pay 
his operatives, to pay interest on capital borrowed, to 
pay taxes and insurance premiums, etc. It also affords 
him as much of a reward for his labor of management as 
he could get if he placed his services at another manu- 
facturer's disposal; and as large a return on his own 
capital as he could get from any other equally safe in- 
vestment. But suppose the price rises to $1.10. For 
every »yard he can sell he gets ten cents over and above 
all costs. This amount we shall call a net profit. 
Of course he desires to sell as many yards as possible. 
He works his mill to its fullest capacity; if he has looms 
that are nearly worn out, he makes haste to replace 
them with more efficient machinery; if he has been 
contemplating the erection of an annex to his mill, he 
pushes the work forward as rapidly as he can. Every 
other manufacturer in his line does the same, and in 
time the increased supply of the fabric forces the price 



56 INTRODUCTION TO ECONOMICS 

down, until it reaches $i, where the manufacturer no 
longer has any reason for increasing operations. Possibly 
the price goes still lower and reaches ninety cents. This 
does not pay all costs, but the manufacturer may still 
continue to produce, as it may be better for him to 
pocket his loss than to let the mill stand idle. But it 
is plain that he will curtail operations wherever he can. 
He will discharge his least efficient workmen, and dis- 
continue the use of his least efficient machines. Every 
other manufacturer, in greater or less degree, will do 
likewise. So the supply falls away and the price rises 
toward $i. This, then, is the normal price — -a price 
that just covers cost of production. 

7. While it may he to the interest of the producers 
of a commodity, as a body, to limit produc- 
tion and so maintain prices at a high level, 
it is to the interest of each individual producer 
to extend his own production. 
If, then, the price of a commodity exceeds cost, forces 
are set in motion which tend to bring the price back to 
the cost level. Now, every producer desires an excess 
of price above cost, and the greater the excess, the better 
he likes it. If a manufacturer can produce a certain 
fabric at a total cost of $i, and can sell it at $i.io, he 
enjoys a very comfortable net profit; and the same 
thing is true of all other manufacturers in the same line, 
and they might continue to secure this net profit if 
each one would refrain from enlarging his output. 
There is, then, something illogical in the conduct of the 
several producers. Each of them is eager to get as large 
a sum of net profit as possible; but the result of their 
action is that nobody long continues to get any net 
profit at all. 

The reason for this is that when producers are numer- 
ous, each contributing only a small percentage of the 



NORMAL COMPETITIVE PRICE 57 

aggregate product, no single one of them can exert a per- 
ceptible influence upon price through any practicable 
increase in his operations. Suppose our manufacturer in- 
creases his output 100 per cent. Probably this does not 
reduce the price one fiftieth of a cent a yard. There- 
fore he obtains nearly twice as large a sum of net profit 
as he would have done if he had kept his output un- 
changed in volume. The temptation to increase his out- 
put, then, is very strong; it is strengthened by the fact 
that he knows that every one of the other thousand 
producers is subject to the same temptation; some will 
yield to it, then others, finally all; and those who yield 
first will be the ones who will get the greatest sum of 
profit. Under the conditions, the best thing for the 
manufacturer to do is to yield to the temptation the 
moment it offers. 

And this is what must inevitably occur where com- 
petition exists — where each producer may increase his 
output if he desires to do so. However much it may be 
against the interests of all the members of a group of 
producers to increase operations, it is to the interest 
of each one to increase his own operations, if the price 
of his products exceeds their total cost. 

Often, in American history, have different classes of 
producers planned a universal curtailment of production, 
in order to force prices above cost level and hold them 
there. At one time the producers of raw petroleum, at 
another time the producers of wheat, at still another 
time the producers of cotton, have beguiled themselves 
with such plans. If each cotton producer would plant 
ten per cent less ground next year, the price of cotton 
would probably rise twenty per cent, and every pro- 
ducer would get more money for less labor. Suppose 
that the cotton producers make a general agreement to 
this effect. Well, every producer who violates his agree- 



58 INTRODUCTION TO ECONOMICS 

ment, and doubles his acreage, will get the benefit of 
the high price, and the additional benefit from an 
unusually large quantity to sell. Each producer, having 
his own interest at heart, and suspecting the integrity 
of the motives of others, is under the strongest tempta- 
tion to increase his output. Some will refrain from doing 
so; but enough will increase their acreage to keep cotton 
very near to cost price. 

But let us suppose that the cotton producers are able 
to bind themselves legally to diminish production, ten, 
twenty, fifty per cent, or are able to form an association 
whose ruthless use of physical force terrorizes each indi- 
vidual into observing the restrictions on production fixed 
by the association, as has at times been done in the 
narrower field of tobacco production. In that case prices 
will cease to hover about cost of production. They will 
be such as always to afford a net profit. Such prices, 
in contrast with normal or competitive prices, are called 
monopoly prices. They are controlled by laws, but these 
laws are quite different from those which prevail in com- 
petitive industry. 

8. Deviations from the normal level of prices are 
quickly or slowly corrected according to the 
ease or difficulty with which expansion and 
contraction of production take place. 

If one out of a number of grades of ordinary cotton 
cloth rises to an abnormally high price, the supply of 
that grade of cloth increases almost immediately. The 
labor and machinery that have been employed in pro- 
ducing other grades are diverted to the production of the 
grade that is in demand. A few weeks or months prob- 
ably suffice to bring the price back to the normal level. 
If the price of all grades of cotton cloth rises above the 
normal, a longer period of readjustment is necessary. 
New factories must be built; new workers trained for 



NORMAL COMPETITIVE PRICE 59 

the industry. If the industry has been long established, 
indeed, expansion can take place in less time than would be 
required if the industry were newly estabHshed. Let us say 
that there are, in a long established industry, 1000 mills 
producing the same grade of goods and selKng them in a 
common market at a uniform price. Fifty of these mills 
become so dilapidated each year, through age, that they 
are dismantled; fifty mills of equal capacity must be put 
up each year in order to maintain a constant supply of 
goods. If prices are so low that not all costs of produc- 
tion are covered, no new mills are erected to take the 
place of those which are abandoned, and a part of the 
supply fails. If prices are above cost, instead of fifty 
new mills, there may be 100, and the increased supply 
tends to draw prices back toward the cost level. 

When an industry is new, to be sure, adjustment does 
not take place so automatically. All the mills are, by 
assumption, new, and presumably nearly equal in effi- 
ciency. If prices rise, new mills are erected, but if prices 
fall there are none that will be dismantled. All will 
suffer together. This is a condition which often occurs 
in countries like the United States where many industries 
are still in a state of rapid expansion. 

9. In agriculture, the uncertainties of the seasons 
often interfere with the operation of the laws 
of normal price. 

If the price of wheat is high this year, more than a 
normal acreage will probably be sown to wheat next year. 
The average yield per acre may, however, be low next year 
and the price of wheat may remain high, thus inducing 
farmers to sow a^still larger acreage the year following. 
A succession of good years may then ensue, with the 
result that prices become abnormally low and the wheat 
acreage is much reduced. No evidence of over-production 
is conclusive enough to deter farmers from planting the 



6o INTRODUCTION TO ECONOMICS 

crop for which their fields are most suitable. They sow 
in hope of high prices, only to be frustrated. Each 
season's low prices come upon the farmer unawares. He 
probably ascribes them to some cause other than the true 
one, and continues in his course of over-production, per- 
haps for years. Conversely, high prices may be ascribed 
to false causes — speculation, failure of crops abroad, 
etc. — and consequently fail to set in motion the correc- 
tive influence of expanding supply. It is only by keeping 
in view a number of years that we can discern a normal 
price level for agricultural products. 

10. Deviations from the normal price level are 
greatest where production requires antecedent 
preparations extending over a period of years. 

Every one who has lived in a fruit-growing country 
has had his attention drawn to the extraordinary re- 
turns sometimes secured by the owners of orchards. 
Some fifteen years ago the product of a cherry orchard 
in the Santa Clara valley was sold, on the tree, for 
$200 or more per acre, and a failure of the cherry crop 
is a rare occurrence. Land similar to that upon which 
the cherry trees were grown was to be had at $150 an 
acre; the cost of planting an acre, and caring for the 
young trees up to the time when they became productive, 
would probably have been covered by an equal sum. A 
$200 return on a $300 investment looks very attractive, 
certainly. Why did not more persons enter the business 
of cherry production? Because several years would have 
had to elapse before they could secure any returns, and 
in the meantime the price of cherries might have fallen 
so low that there would not have been even a fair return 
in their production. 

In 1885 a Nebraska landowner planted 200 acres of 
catalpa trees. In 1907 he cut the trees and sold the 
product — posts, telephone poles, and wood — for a sum 



NORMAL COMPETITIVE PRICE ,6i 

which, after paying at a liberal rate for all labor in the 
care of his trees and in cutting and marketing them, 
yielded over lo per cent compound interest on his orig- 
inal outlay for land and for planting. This is an un- 
usually high return on landed investment in that part 
of the country. Why then after this demonstration did 
not more men plant catalpa trees? Well, who could 
foresee the prices that would prevail twenty years later? 
It is entirely conceivable that for a hundred years or 
more those who plant trees will receive an abnormally 
high return on their investments. On the other hand, 
the business of tree planting may easily be carried to 
an extreme, with the result that for a long period of 
time those who plant trees will receive practically no 
return. 

11. Where several commodities are the result of 
a single process of production, it is im- 
possible to determine the cost of each one 
separately. The group as a whole has a 
normal price; the separate commodities have 
not. 
Some commodities are invariably produced together, as 
beef and hides, cotton and cotton seed, wool and mutton. 
In most great industries, it is found possible to make use 
of parts of the raw material that are ordinarily regarded 
as waste. Thus, in the refining of petroleum, besides the 
main products, kerosene and gasolene, a host of by-products 
— lubricants, tars, dyes, etc. — are produced. How much 
does it cost' to produce each of these? Nobody can tell. 
They could not be produced at all, in commercial 
quantities, were it not for the immense capital engaged 
primarily in the production of kerosene and gasolene. 
Part of the cost of the use of that capital ought to 
be counted as cost of by-products. But it is not 
possible to say how great that part should be. No 



62 INTRODUCTION TO ECONOMICS 

one can say how much it costs to produce hides, or 
cotton seed, or wool. There is, of course, an ascertain- 
able cost, and hence a definite normal value, of live cattle, 
of sheep, of unginned cotton, of petroleum products as 
a whole. If the price of beef, added to the price of 
hides and other by-products, is more than reasonable 
compensation for the cost of raising cattle, the business 
of cattle-raising tends to expand. And so with other 
cases of joint products. 

The same principle is very clearly illustrated in the 
business of transportation. A ship or a railway train 
may carry passengers of different classes, as well as a 
wide variety of baggage and freight. How much does it 
cost a railway company to carry a particular passenger 
from Chicago to New York? From one point of view 
the cost appears to be almost nothing. The train would 
run even if this passenger remained in Chicago. An 
empty seat would be hauled from city to city, instead of 
an occupied one. The passenger adds his weight to the 
load that the engine must draw, but a few cents would 
easily cover this cost. What is true of one passenger is 
true of any other; he could be carried for nothing, if 
the costs entailed by his presence were alone considered. 
The cost of running the train, however, is a very large 
sum, and this is the immediate cost of carrying the 
passengers as a body. 

But the cost of running trains is not the whole cost of 
the service of the railway company. The track must 
be kept in repair; interest must be paid on capital 
invested in roadbed, terminals, etc. How much of this 
cost is assignable to the passenger service, how much 
to the freight service? It is impossible to say. Of the 
total cost of operating the railway a certain percentage, 
usually a small one, can be assigned definitely to the cost 
of running passenger trains: wages of crews, wear and 



NORMAL COMPETITIVE PRICE 6^ 

tear on engines and cars and interest on the capital 
invested in them. Another percentage may be assigned 
to the freight service. But the greater part of the cost 
will remain, to be distributed between the two services 
more or less arbitrarily. Railway accountants sometimes 
attempt to assign costs more definitely than this, but 
their results are artificial. 

12. The cost of production varies from establish- 
ment to establishment. At any given time 
normal price is determined by the costs of 
those who produce under the greatest dis- 
advantages, or the marginal producers. 
Where the cost of a particular commodity is ascer- 
tainable, and any one is free to enter upon its produc- 
tion, the price constantly tends toward the level of cost. 
Cost, then, may be said to determine normal value. It 
IS, however, to be borne in mind that cost itself is some- 
thing variable and fluctuating. Cost of production in 
any industry is greater for some producers than for 
others. A given grade of cotton goods may be produced 
either in Rhode Island or in North Carolina. It may 
cost an average of ten cents a yard in Rhode Island, and 
nine cents a yard in North Carolina. Some Rhode 
Island factories are better than others; perhaps the cost 
of producing the cloth is eight cents in the best fac- 
tories and twelve cents in the worst equipped ones. 
And similar gradations may exist in North Carolina. So 
when we say that normal price is fixed by cost of pro- 
duction, exactly what do we mean? Average cost? Great- 
est cost? Least cost? 

It may be supposed that a factory which produces 
at a cost of eight cents will run on full time, and with 
full working force, if the price is 8 J cents. If the price 
is ten or twelve cents, it can do no more, unless it can 
be expanded by the erection of an annex. Let us sup- 



64 INTRODUCTION TO ECONOMICS 

pose that it would take a year to construct such an 
annex and get it into working order. In the meantime 
the factory produces as much as it can when the price 
rises; but so it would have done if the price had not 
risen. So far as this factory is concerned, the rise in 
price does not immediately create an expansion of supply 
that reacts upon the price. This factory, then, cannot 
be said to be in a position to control prices. 

But let us suppose that there are other factories which 
produce at a cost of nine, ten, eleven, twelve cents a 
yard. So long as the price remains at 8j cents, none 
of these, we may assume, will be in operation. As 
soon as the price rises to nine cents, the factories pro- 
ducing at that cost will open their doors, and by increas- 
ing the supply of goods, will tend to check further rise 
in prices. If prices rise nevertheless, the factories pro- 
ducing at a cost of ten cents will begin operations, ancf 
will exert their influence on supply and on price. When 
the price rises to twelve cents, it will be the factories 
producing at this cost that will tend to check a further 
rise in price. When the price is twelve cents, the costs 
of production of the better equipped mills — those pro- 
ducing at eight and one half, nine, ten, and eleven 
cents — have little to do with the determining of price. 
If the price rose a little higher, or fell a little lower, 
these factories would continue to produce exactly as much 
as they do when the price remains at twelve cents. 
They do not, therefore, regulate the supply. This the 
twelve-cent mills do, since, if the price falls, they are 
ready to drop out, and reduce supply. 

It is not to be understood, however, that a manufac- 
turer can say: ''I produce at a cost of twelve cents; I 
must have at least that price," and so force the price 
up to twelve cents. If the market demands that manu- 
facturer's contribution to the supply, it must pay twelve 



NORMAL COMPETITIVE PRICE 65 

cents for every part of the supply. The manufacturer in 
the least favorable position cannot fix the price at his cost. 
He can only withhold what he might have supplied, 
and so bring to bear upon the market some small pres- 
sure, making for higher prices. 

It is only in a restricted sense, then, that we can say 
that normal prices are fixed by cost of production. 
Those who produce at a cost of twelve cents, by their 
action in placing a product on the market or withhold- 
ing it, make an attempt at holding the price at that 
point. Perhaps the task is too great for them; the 
price slips away; and those producing at a cost of eleven 
cents make an endeavor, by the same means, to hold 
prices at their cost level. They also may be unequal to 
the task, but at last the price rests in the hands of 
producers who are just able to hold it at their costs. 
We may think of these as being on the fringe or "mar- 
gin" of production; they are often called, in economics, 
the marginal producers. 

13. In the long run competitive prices tend to- 
ward the level of costs of the most efficient 
producers. 

The price does not, however, rest permanently with the 
same marginal producers. Those producers whose costs 
are less than the price are continually reaping profits; 
they invest them in new mills, equally well equipped, 
and borrow capital further to increase their produc- 
tive capacity. In time they greatly increase their out- 
put, and this tends to reduce the price of the commodity. 
The marginal producers find the burden of holding the 
price at their cost level growing heavier and heavier; 
soon the price breaks away from them altogether, and is 
held for a time at the cost level of slightly more efficient 
producers. But the most efficient producers continue to 
enlarge their works; an increasing supply is thrown upon 



66 INTRODUCTION TO ECONOMICS 

the market, and the price settles to a still lower level, 
where it equals cost to producers who formerly enjoyed 
a slight profit. In this way prices are continually gravi- 
tating toward the level of cost of the most efficient 
producers. 

It may therefore be said that for a short period price 
is determined by the costs of production of those who 
produce at the greatest expense, but whose contribution 
to the supply is necessary in order that the existing 
demand may be met. In the progress of time, however, 
such producers are unable to hold prices at their cost 
level, and are forced out of business. The final adjust- 
ment — if it should ever be attained — would leave price 
at the level of cost to the most efficient producers, all of 
whom would stand on a plane of equality as to costs. 

This does not mean, however, that the price of a given 
conmiodity must continue to decrease. The cost itself 
may increase, for the more efficient as well as for the 
less efficient producers. As we have used the term, cost 
includes the value of raw materials and fuel; interest 
on capital, whether fixed in land, buildings, and ma- 
chinery, or invested in raw materials, etc.; wages of 
all labor employed; and a number of lesser items — 
taxes, insurance premiums, etc. Now, every one of these 
elements in cost is perpetually fluctuating in magnitude 
according to its own peculiar laws. The sources of 
raw material may be approaching exhaustion; wages 
and interest may be rising; taxes may be growing 
heavier. But while such an increase in costs may pre- 
vent the more efficient factory from producing as cheaply 
as before, it burdens the less efficient proportionately. 
It cannot, then, prevent prices from tending toward 
costs to the most efficient producer. 

14. Summary. 

The market prices of commodities are subject to con- 



NORMAL COMPETITIVE PRICE 67 

tinual fluctuations. These fluctuations are greatest in 
the case of commodities that rapidly deteriorate and 
that are dependent upon a local market. Despite such 
fluctuations there is a discernible tendency toward a nor- 
mal level of prices. This level is determined by the cost 
of production. The force that causes market prices to 
hover about cost of production is competition between 
the several producers. 

The ease or difflculty with which supply may be in- 
creased or diminished determines the degree of possible 
deviation of prices from the normal level. Marked devia- 
tions are frequent in the case of agricultural products, 
since unforeseen seasonal influences are constantly vitiat- 
ing the calculations of the producers. Great deviations 
are possible where production is governed by calculations 
looking to the remote future. 

The costs of production in every industry vary con- 
siderably from establishment to establishment. In short 
periods of time the costs of those establishments which 
labor under the greatest disadvantage play a chief part 
in determining prices. In the long run prices tend toward 
the level of cost of those establishments which enjoy the 
greatest advantages in production. 



CHAPTER IV 
MONOPOLY PRICE 

1. The price of a commodity may he controlled 
by dealers or producers through control of 
supply. 

As has been shown in the preceding chapter, the mech- 
anism which keeps prices hovering about cost of pro- 
duction consists in the automatic adjustment of supply 
to demand. If price rises, supply increases, and thus 
price is forced down again. If then the supply of a com- 
modity can be controlled by the producers, the price is, 
in some measure, also within their control. With this 
control, the producers are in the happy situation where 
they can, within limits, enrich themselves at their pleas- 
ure. It is no wonder, then, that producers and dealers 
from very early times have sought to bring supply under 
control. Joseph controlled the total supply of grain in 
Egypt, we are told; he was thereby enabled to charge 
whatever prices he pleased, and the prices he fixed were 
such that he got in exchange for his grain all the pos- 
sessions that the Egyptians had. In ancient and medi- 
aeval times, when roads were bad and th-e costs of car- 
riage prohibitive, whoever should buy up the stock of 
grain in a town would make himself practically master 
of the town. He could measure out the grain in small 
quantities, charging whatever prices seemed good to him. 

To-day, as in earlier times, business men are constantly 
seeking to gain control over the prices of the commodities 
in which they deal. That some are at least partially 

68 



MONOPOLY PRICE ' 69 

successful in this is shown by the great number of articles 
the prices of which do not vary. Price control extends, 
however, far beyond the field of constant prices. A man 
who has absolute control over the sale of a commodity 
may be expected to fix high prices in tunes of prosperity, 
low prices in times of depression, and in many cases this 
policy appears to be followed by those men who now 
have practical control of the prices of the commodities 
which they sell. 

2. Power to control prices is commonly termed 
monopoly. 

In the strictest sense of the term, monopoly is the 
exclusive privilege of selHng a commodity or a service. 
Most governments have a monopoly, in this sense, of 
the postal service. Some governments monopoHze the 
sale of tobacco; others, the sale of salt; still others, the 
sale of spirituous liquors. The exclusive privilege of sale 
is sometimes granted by government to private individuals 
or corporations. A common example of this kind of 
monopoly is the patent by which an inventor is assured 
control over the use of his invention, or the copyright 
by which an author is given control over the sale of his 
book. In many cases a private corporation is given the 
exclusive right to supply a city with water, gas, or elec- 
tric light. In some cities only one street railway com- 
pany is chartered, and in some countries steam railway 
com^panies are given monopolies of the transportation 
service within specified areas. Monopolies created by 
law, then, are both numerous and important. In a dem- 
ocratic state they are not likely to grow into a serious 
abuse; in a state where the government is not really 
controlled by the people, such monopolies may become 
exceedingly oppressive. 



70 INTRODUCTION TO ECONOMICS 

3. A partial monopoly can be established by private 
persons, through agreements fixing prices or 
limiting supply. 

Let us suppose that the producers of a given com- 
modity agree among themselves not to sell below a cer- 
tain price, or, what leads to the same result, not to pro- 
duce more than an amount so small as to command 
scarcity prices. If producers are few — • say half a dozen 
— such an agreement may stand. No one can materially 
increase his sales without attracting attention; more- 
over, no one can increase his sales without an immediate 
effect on price. If the producers number millions, such 
an agreement is empty words; almost any one can vio- 
late it without detection, and without any appreciable 
effect on price. And the number of violators of the agree- 
ment will be so great that no control of supply or of 
price can be exercised. 

When the number of producers is small, then, there 
may be effective control of supply. But such control 
cannot long be retained unless new producers can be 
kept out of the field. 

The producers of cotton yarn of the higher grades are 
not very numerous. It is therefore conceivable that 
they might agree to limit supply and force the price to a 
point paying a ''fair" profit. But it is not a difficult 
matter to build and equip a mill to produce a given grade 
of cotton yarn. If, then, the price were forced to a high 
level, new producers would soon appear. These would 
enjoy the benefit of the high price, although to effect sales 
they would have to cut prices slightly. The original 
producers would have to reduce their prices; the new 
producers would then cut still lower, and so on until 
the price had reached cost of production. Indeed, the 
price would almost certainly go lower than this, for 
the number of producers, each striving to get more cus- 



MONOPOLY PRICE 71 

tomers, would have increased. The last state of the 
cotton yarn business, accordingly, would be far worse 
than its first. We have had in America not a few ex- 
amples of attempted monopolies which in the end merely 
intensified competition. 

4. Permanent price control may he secured through 
control over some element essential to produc- 
tion, such as labor, raw material, means of 
transportation. 

If the industry which it is sought to monopolize re- 
quires a very high grade of skilled labor, and the mem- 
bers of the combination control the whole supply of labor 
of this grade, the monopoly may rest secure until new 
labor can be trained for the shops of would-be com- 
petitors. If the only satisfactory way of training such 
labor is through apprenticeship under men already work- 
ing in the trade, it becomes difficult indeed for a com- 
petitor to get an independent supply of labor. This 
situation might become a serious one in some indus- 
tries were it not for the fact that it is not easy for 
one set of employers permanently to control their work- 
men. The latter know that at any time they can thwart 
their employers' monopoKstic schemes by accepting em- 
ployment with competitors; and this knowledge is made 
good use of, in forcing constantly higher wages. Where 
monopolies of this kind have arisen, they have usually 
broken down because of disputes between the employers 
and their workmen. 

Some products depend upon supplies of raw material 
that are found in comparatively few parts of the earth, 
and in Kmited quantity. If a combination of producers 
can get possession of all or most of the mining or agri- 
cultural lands which are capable of yielding a certain 
product they may win their desired freedom from the 
danger of new competitors. Anthracite coal, for ex- 



72 INTRODUCTION TO ECONOMICS 

ample, is found only in a restricted area in the United 
States. A combination of capitalists of very great wealth 
might with comparative ease control the total output — 
and indeed, something of the kind now exists. Such a 
combination has nothing to fear from new competitors, 
although of course it must meet the competition of 
producers of other fuels. 

In the history of the American petroleum industry, 
there was a time when the Standard Oil Company, 
through ownership of pipe Hnes, enjoyed an immense 
advantage over its competitors, who were compelled to 
ship petroleum over the railways. The Standard Oil 
Company was not, indeed, enabled by this advantage to 
destroy competition entirely; its control over supply was, 
however, notably strengthened by the ownership of the 
pipe lines. And even when pipe Hnes were by law made 
common carriers, required to serve all on equal terms, 
their location, designed first of all to serve the Standard 
Oil Company, continued to afford an advantage to that 
company. 

5. Permanent price control is sometimes main- 
tained through the systematic intimidation of 
competitors. 

Let us suppose that there is a combination of the 
more important producers of coal, who yet have nothing 
like complete ownership of the coal lands, and that there 
are a number of small competitors whose natural market 
is a city which we will call X. Other markets, we will 
assume, are so far distant that cost of transportation 
prohibits their supply from the mines of the small pro- 
ducers. The combine, let us say, has mines from which 
it can supply the market X, as well as a great number 
of mines supplying other cities. If, then, it desires to 
destroy the business of its small competitors, it may 
decide, for a while, to sell coal in X for less than the 



MONOPOLY PRICE 73 

cost of raising it from the pit. This the combination 
can afford to do, because it is enjoying high profits 
from its monopolistic position in the supplying of other 
markets. Of course the small competitors can sell no 
coal at prices which will meet those of the combine; 
very soon they become discouraged and retire from busi- 
ness. Then the combine can raise prices of coal in X to a 
profit-yielding point. The small producers will probably 
not again attempt to compete, knowing that the same 
tactics will again be employed to destroy their business. 

Of course, if coal were easy to transport, this method 
would prove very expensive to the monopolistic com- 
bination. An enterprising dealer in the town X, finding 
that the combination sold coal there at much lower prices 
than in town Y, might buy up coal in the former place 
and ship it to the latter. On every ton of coal sold in 
X, we have assumed, the combination is losing money; 
and every ton sold in Y helps to depress the price there, 
to the further disadvantage of the combine. In a sense, 
it would be underselling itself. 

Accordingly, some other method of destroying com- 
petitors must be employed when the commodities which 
it is sought to monopolize are of little weight and bulk, 
as compared with their value, and hence easily trans- 
ported. Suppose that a monopolistic combination con- 
trols most of the manufacture of cigars, and that an 
overbold outsider, eager to share the benefits of high 
prices, enters the field. He may place on the market 
an excellent brand of cigars, charging for them less than 
the combine charges for similar ones. The combine can- 
not lower the prices of all cigars in the competitor's 
vicinity, for in that case dealers will buy them up and 
express them to all parts of the country; and thus the 
combine will be inflicting losses upon itself. But there 
is another method which it may find efficacious. 



L 



74 INTRODUCTION TO ECONOMICS 

Let us say that the independent producer calls his 
brand of cigars the ''Rex." It is his all; his fortune is 
bound up with its fate. The combine has 500 brands; 
it makes profits on all of them. Accordingly, it can 
afford to put out a new brand of cigars — ■ say the 
''Regina" — ^ for half the price of the Rex, though of 
as good quality, and place it on the market wherever 
the Rex is sold. Before long the Rex is no longer pur- 
chased; its producer goes out of business. Then the com- 
bine puts worse tobacco into the Regina, until at last, 
like all its other products, this cigar is dear at the price. 

6. Monopolies that are not based upon privileges 
granted by government are rarely complete, 
and consequently are influenced in the fixing 
of prices by fear of competition. 

To destroy a competitor is a proceeding that almost 
always involves heavy expense. If a powerful com- 
bination desires to destroy a smaU but vigorous com- 
petitor, it is often obliged to sell below cost, not only 
to those persons who actually deal with the competitor, 
but also to many other persons in the same market. The 
combination can compel its competitor to lose money, 
but in so doing it loses money itself — sometimes ten 
dollars for every doUar its competitor loses. Accordingly, 
it is often cheaper for a combination to buy up the plant 
of a competitor, even at an unreasonably high price, than 
to force the plant to close down through price-cutting. 
If the competitor refuses to sell to the combination, the 
latter may adopt a ''live and let live" policy, agreeing 
to respect the competitor's right to his territory and 
established trade, so long as he does not appear obnox- 
iously active in increasing his business. All the great 
American trusts have competitors toward whom they 
observe a policy of toleration. The trust sets a price 
upon its products, and the independent concern sells at 



MONOPOLY PRICE 



75 



the same price. If, however, this price is so high as to 
offer great profits, the independent concerns grow stronger 
and stronger, and in the end extend their business, en- 
croaching upon the field of the monopoly. 

It is not alone the competition of the existing inde- 
pendent concerns that a monopoly has to fear. Very 
high prices are likely to induce new competitors to enter 
the field. Such competitors must either be driven from 
the field by the expensive policy of price-cutting, or 
some of the business of the monopoly must be surren- 
dered to them. In fixing prices, then, the monopohst 
must have regard not only for actual competition, but 
also for such competition as might arise, or potential 
competition. 

7. A complete monopoly will fix prices at a level 
that yields the maximum return above all costs. 

Suppose that a monopoly has complete control of the 
salt that is to be sold in the United States. It may cost 
one cent a pound to produce it. At what price will the 
monopoly sell it? If the price is one cent, perhaps one 
billion pounds can be sold. If the price were raised to 
two cents, who would eat his food unsalted? Who would 
economize salt in the least? It is safe to say that there 
are few persons in the United States so poor that they 
would not go on eating as much salt as before. And the 
same thing would be true if the price were raised to five 
cents a pound — • a price of which four fifths would be 
monopoly profit. 

But not all the salt is for table use; a large part of the 
total supply is used for live stock and for manufacturing 
purposes. If the price of salt rises, the use of it for these 
purposes declines. When salt is very cheap many farmers 
scatter it on the ground for their cattle, or leave it in 
troughs with no shelter, where the weather devours more 
of it than do the cattle. High price would mean econ- 



76 INTRODUCTION TO ECONOMICS 

omy. So, at two cents a pound, probably not more than 
900,000,000 pounds will be used, instead of 1,000,000,000. 
At five cents a pound the amount taken might shrink to 
800,000,000 pounds; at ten cents, to 700,000,000; at 
twenty, to 500,000,000. Were the price forced up to $1 a 
pound, very likely great economy would be exercised even 
in the use of salt in human food. Perhaps not more than 
80,000,000 pounds would be used. 

Now, while the monopoly would make the enormous 
profit of ninety-nine cents a pound at the last-mentioned 
price, this would be a very irrational price for it to set. 
The total profit from the sale of salt would, according to 
our assumed volume of sales, be $79,200,000. And this 
would be much better than selling 1,000,000,000 pounds 
at cost, or 900,000,000 at two cents. The latter price 
would yield just $9,000,000 profit. At five cents the mon- 
opoly would get a profit of $32,000,000; at ten cents, of 
$63,000,000; at twenty cents, of $95,000,000. So twenty 
cents is really a more profitable price for the monopoly 
than $1. At twenty-five cents, however, 400,000,000 
pounds might be taken; and this would mean a profit 
aggregating $96,000,000. This, then, is a still better price 
than twenty cents, from the monopolist's point of view. 
Let us suppose that at thirty cents 300,000,000 pounds 
will be taken. The profit at this price would amount to 
only $87,000,000. This price, accordingly, is too high; 
and the best price for the monopolist lies between twenty- 
five and thirty cents. 

Of course this would be an exorbitant price; and far 
more extortionate than any existing monopoly price. But 
given the conditions — ■ a complete monopoly of salt — ex- 
tortionate prices can be established. One must have salt; 
he must have a certain amount of it. There is nothing in 
the world that can be substituted for it. And even if the 
price were exorbitant, the cost of salt would form no very 



MONOPOLY PRICE 77 

large item in any one's expenditure. No one would leave 
the country to escape the monopoly. 

8. The greater the elasticity of demand for com- 
modities controlled by monopolies, the lower 
will be the price that yields the maximum 
monopoly profit. 

The demand for salt is peculiarly inelastic. To do 
without salt altogether is impossible; to reduce consump- 
tion always involves hardship. Most other commodities 
can be replaced by substitutes. One kind of food readily 
takes the place of another; cottons may be replaced by 
woolens, linens, and silks; wood for building purposes 
may give way, in large degree, to stone, brick, and con- 
crete. There is almost always an ill-defined boundary be- 
tween the consumption of one commodity and that of 
another, and changes in relative prices shift the boundary 
now in one direction, now in another. 

Let us suppose that a monopoly has gained control of 
the entire supply of beef in the United States. Perhaps 
the cost price at which beef can be placed on the market 
is ten cents a pound. With beef at this price, the Ameri- 
can people might conceivably eat 80 pounds per capita 
— 8,000,000,000 pounds in round numbers. At eleven 
cents, some of the poorest people would cease eating beef 
and use mutton or pork instead, or use less meat of any 
kind. Perhaps the amount consumed would fall to 
7,000,000,000 pounds. That would give the beef mon- 
opoly a princely income — $70,000,000. At twelve cents 
the amount consumed might fall to 6,000,000,000 pounds; 
but this would yield a net profit of $120,000,000; and if 
the amount at thirteen cents fell to 5,000,000,000 pounds, 
the profit would yet amount to $150,000,000. Fourteen 
cents and 4,000,000,000 pounds would 'be still better for 
the monopoly — $160,000,000. But fifteen cents and 
3,000,000,000 pounds would be a step backward, for the 



78 INTRODUCTION TO ECONOMICS 

profit would be only $150,000,000. Fourteen cents, then, 
is the most that the monopoly could wisely charge. 

Of course, if the demand does not shrink so rapidly as 
I have assumed, the maximum price can safely be placed 
at a higher figure. If the shrinkage is more rapid than I 
have assumed, fourteen cents is too high. 

As the number of commodities offered to the public 
for consumption is continually increasing, it is safe to say 
that the average consumer grows less and less dependent 
upon any one. Demand, accordingly, grows constantly 
more elastic, and the power of monopolies to fix prices 
at a high level constantly diminishes. 

9. In fixing prices, a monopoly is more or less 
extortionate according as it pays less or more 
attention to the ulterior effects of high prices. 

If it is the intention of the monopolist simply to ex- 
ploit the beef market for one year, — to corner the 
present supply, make the most out of it, and then retire 
to live on his plunder, — he may find that at fourteen 
cents there will be no greater shrinkage of demand than 
has been assumed in the foregoing example, and this 
will then be the best price for him to set. Most persons 
who are accustomed to this article of diet will continue 
to buy it even at the higher price. But in a year, more 
and more of them will form other habits. A corner in 
beef organized in the following year might not be able 
to charge more than twelve cents without diminishing 
total net profit; and in the third year a corner might 
not be able to charge more than eleven cents. Accord- 
ingly, ' a monopolist who does not mean to retire from 
business must generally avoid charging a price that would 
give the highest possible returns for one year. He must 
fix prices in such a way as to keep the bulk of his custom 
from year to year. And this is one reason why modern 
monopolists are less extortionate than the ancient and 



MONOPOLY PRICE 79 

mediaeval "engrossers" of the necessaries of life. As a 
rule, the modern monopolist hopes for steadily increas- 
ing profits from a growing business; he therefore culti- 
vates his cHentele through prices that are moderate. 

If a ring of speculators of immense wealth should buy 
up the entire American cotton crop, they could fix the 
price of cotton at twice the normal price, and yet sell 
most of it. Cotton fabrics would advance in price, but 
not proportionately, for many persons would go without 
cotton cloth rather than pay unreasonably high prices. 
The profits of cotton manufacturers would fall; wages 
of cotton operatives would be reduced. The cotton man- 
ufacture would decline; many cotton operatives would 
go into other employments. Cotton production in Egypt, 
India, and Australia would be stimulated. It would 
take more than a year, however, for such adjustments to 
take place. In the meantime the speculators would have 
sold their cotton at high prices, and reaped their ex- 
tortionate profits. The injury occasioned by the changes 
in cotton manufacture would fall upon the producers of 
the succeeding American cotton crops. 

If a combination of capitalists were to secure pos- 
session of the entire business of petroleum refining, it 
would be no less easy for them to obtain exorbitant 
profits for one year. But the decline in consumption 
that would follow, when time had been given the people 
to provide themselves with other sources of light and 
power, would seriously impair the future profits of the 
petroleum monopoly. Now, no profit, however exorbi- 
tant, on a single year's sales, is to be compared with 
comfortably high profits for an indefinite series of years. 
Great fortunes are to be obtained through the permanent 
monopolization of the means of producing a commodity, 
rather than through cornering the visible supply and 
exacting excessive prices, without regard to the effect of 



8o INTRODUCTION TO ECONOMICS 

the policy on future sales. For this reason monopolies 
of the permanent kind are continually increasing in num- 
ber and importance, while it is only rarely that a tempo- 
rary monopoly is successfully carried through. 

10. In order to secure the maximum profit, a 
monopolist often endeavors to classify con- 
sumers, and to burden each class according 
to its ability to pay high prices. 

There are some classes of consumers who will pay in- 
creased prices without a murmur, while other classes will 
not only feel greatly aggrieved, but will even refuse to 
buy, when prices are appreciably increased. To the rich 
it makes little difference whether beef is high or low. 
If the monopoly can array its customers in groups, 
according to their readiness to pay high prices, it can 
grade its prices accordingly. The classes that will endure 
only a slight increase in price are given prices so moder- 
ate that they continue to buy, while the classes that 
are less apt to complain over an increase are forced to 
pay prices that yield a higher profit. This is much 
better for the monopoly than to fix an average price 
which drives away the former classes, and does not ex- 
ploit the latter to the highest possible degree. 

How, then, can a monopoly make such a division of 
its customers into classes according to their profit-yielding 
capacity? One way consists in different prices for differ- 
ent localities. If there is greater per capita wealth in 
California than in North Dakota, a monopoly would 
charge higher prices in the former than in the latter 
state, even allowing for all costs of transportation. Sup- 
pose that the cost of production of beef for North Dakota 
is ten cents, and the cost of transportation practically 
nothing; the cost of production of beef for California 
we may assume is the same, and the cost of shipping two 
cents a pound. The beef may be sold in Dakota for 



MONOPOLY PRICE 8i 

eleven cents and for fifteen in California — giving a net 
profit of one cent in the former state and three in the 
latter. Of course, the difference could be as great as 
this only in case shipping beef in small quantities is 
expensive; otherwise outsiders would buy beef in Dakota 
at eleven cents, ship it to Cahfornia, and make a good 
profit. And here we have one Hmitation upon a mon- 
opoly's power to vary its charges for different locaKties. 
The difference cannot permanently remain at a figure 
which is greater than the sum an outsider would have to 
pay in transporting the monopoly's goods from the point 
where they are cheap to the point where they are 
dear. 

In the case of many goods, however, different qualities 
are sold to different classes of consumers. The choicest 
cuts of meat go to one set of consumers, and the remain- 
ing cuts, in order of toughness, to the various sets of con- 
sumers who have less to spend. Now the consumers of the 
cheapest beef may stand a slight increase in price before 
substituting something else for beef; while those who 
consume the best quaHty may see the price double be- 
fore substituting even a cheaper grade. The far-sighted 
monopolist, then, instead of increasing the prices of all 
grades at a uniform rate, will so distribute the increase 
of price as to burden each class of customers as much 
as they will bear without withdrawing their custom. 

In some cases where no real differences in quality 
exist, the consumer is made to believe that there are such 
differences. Some years ago — and perhaps to-day — 
there were several grades of salt on the market, selling 
at different prices. The manufacturer who produced 
them has admitted that they were all exactly the same. 
The classes who could afford to pay high prices for salt 
bought the grade that was alleged to be the best; those 
who could pay less bought cheaper grades. Thus the 



82 INTRODUCTION TO ECONOMICS 

manufacturer, who enjoyed a limited monopoly, was able 
to make each class of consumers pay according to ability. 
It is easy to see how far this principle might be carried 
in the case of such articles as soap, chocolate, canned 
goods. It is a wise man who knows what ingredients 
go into these commodities; and if the manufacturer, 
who must know, says that one is purer and more choice 
than another, what can you or I do but accept his 
statement and pay the higher price for the so-called 
better quality? 

11. A monopoly may maintain prices at a higher 
level in the domestic market than in foreign 
markets. 

A few years ago a New York dealer offered for sale 
a considerable stock of watches of a standard American 
make at prices far lower than are commonly charged 
by the manufacturer in the same city. These watches 
had been purchased in England at such low prices that 
the dealer was able to make a handsome profit in bring- 
ing them back to America and selling them at cut prices. 
It is well known that American agricultural machinery 
is often sold more cheaply in foreign countries than at 
home, in spite of the cost of shipping. Before the 
Great War the German steel combination sold steel to 
the British consumer more cheaply than to the German 
consumer, and the American steel trust has frequently 
been charged with a similar discrimination in favor of 
foreign purchasers. The principle is a fairly common 
one; it is probable that of the American monopoHes 
that have invaded foreign markets there are few that 
have not in some degree employed this principle. 

Such discriminations are to be explained by the fact 
that for one reason or another the domestic consumer can 
be made to pay higher prices than the foreign consumer 
will tolerate. In some cases the American consumer can 



MONOPOLY PRICE 83 

be made to pay higher prices simply because he is more 
addicted to careless expenditure. This explains price 
discriminations in the case of such articles as watches, 
razors, pipes, etc. In other cases the foreign consumer 
is favored because he can avail himself of the competi- 
tion of foreign producers, who are excluded from the 
American market by our customs duties. This explains 
price discriminations in such products as steel rails. In 
yet other cases the discrimination is explained by the 
fact that the foreign consumer has access to a greater 
number of substitutes than the domestic consumer. 
12. In railway transportation, the principle of 
discriminatory charges is very widely em- 
ployed under the name of ^^ charging what 
the traffic will bear.^' 
Almost every railway is, in a limited sense, a monopoly. 
It may encounter competition at important business cen- 
ters, but most small cities and towns are absolutely de- 
pendent upon a single line. Leaving out of account 
public regulation of railway rates, we may say that the 
railway will burden each class of shippers according to 
the ability of that class to pay. The shippers of silks 
can be made to pay a high rate per ton mile; the ship- 
pers of bricks must have a low rate, or it will be im- 
possible for them to remain in business at all. If allowed 
to pursue its own devices in rate making, the railway 
would naturally discriminate between the different pro- 
ducers of the same commodity. The owner of a well- 
situated mill would be forced to pay a higher rate than 
the owner of a mill badly situated. The owner of a 
rich farm would be made to pay a higher rate than the 
owner of a poor farm. The shipper who is in a position 
to avail himself of the competition of a rival line would 
receive better rates than the shipper who can use one 
line only. The last form of discrimination was once exceed- 



84 INTRODUCTION TO ECONOMICS 

ingly common. It is under the ban of the law and is 
no longer of great importance. 

13. Monopolies must endeavor to preserve their 
customers^ prosperity, and to assist them in 
meeting competition. 

In spite of the fact that railways hold a monopoly 
position, and avail themselves of the principle of dis- 
criminatory charges, it is very seldom that a railway 
secures excessive profits. This is because the demand 
for railway service is extremely elastic. A high general 
level of rates ''kills business." The perishable fruit of 
Southern California must be carried to the Eastern mar- 
ket over a single line of railway. But that railway can- 
not raise rates on fruit to a very high level without de- 
stroying the business of fruit culture in California. 
Though the railway itself has no competitor, the fruit 
growers are engaged in an active competition with those 
of Florida and the West Indies, and the railway 
must make it possible for its customers to hold their 
own. 

In like manner, a monopoly of anthracite coal must 
sell this fuel at a price so low that manufacturers using 
anthracite are not seriously handicapped in their com- 
petition with manufacturers in other parts of the country 
who use bituminous coal. A monopoly of tin cans would 
have to fix prices at a level low enough to permit the 
industry of preserving fruit to hold its ground against 
the business of drying fruit. The lumber dealers of a 
town may have an inviolable agreement fixing prices, 
but they will not often place prices so high as to handi- 
cap the town in its competition for population and busi- 
ness. Monopoly prices, therefore, are not likely to be 
ruthlessly exorbitant. They are usually not higher than 
the customers of the monopolies can pay without serious 
impairment of their power of survival. None the less 



MONOPOLY PRICE , 85 

they are higher than they should be, and enable those 
who hold a monopoly position to draw to themselves 
a larger share of the social income than their services 
justify. 

14. Summary. 
^^onopoly is attained through the control of the supply 
of a commodity or a service. This control may be 
secured through governmental restrictions or through pri- 
vate agreements fixing prices or limiting output. Mon- 
opoHes resting merely upon the agreements of inde- 
pendent producers are inherently weak. 

If some essential element in the production of a good 
can be controlled by a single enterpriser or by a group of 
enterprisers who are able to work in complete harmony, 
a wellnigh impregnable monopoly may be established. A 
high degree of monopolistic control is often attained 
through intimidation of competitors. Monopolies are sel- 
dom entirely free from competitors, and hence are com- 
pelled to fix prices at a level which offers slight induce- 
ment to competition. 

(/ A complete monopoly will fix prices with a view to 
securing the greatest aggregate return from the entire 
business. The more elastic the demand for a commodity, 
the lower will be the price which affords the maximum 
net return. When it is the aim of a monopoly to hold 
permanent control of the supply of a commodity, it is 
necessary to fix prices at a comparatively low level, in 
order to prevent the demand from dwindling away in 
the course of time. 

In order to gain the greatest monopoly return with 
the least shrinkage of custom, it is often advisable for 
the monopolist to discriminate in prices, burdening 
heavily those who can be made to pay high prices, while 
levying moderate charges upon those who cannot pay 
high prices. In railway transportation, this practice is 



86 INTRODUCTION TO ECONOMICS 

commonly described under the name of ''charging what 
the traffic will bear." No enlightened monopoly will 
charge prices so high as to handicap its customers in 
their competition with persons not subject to the control 
of the monopoly. 



I 



CHAPTER V 
THE COST OF PRODUCTION 

1. A complete explanation of prices involves a 
statement of the laws governing the costs of 
production. 

The preceding chapters have shown that the costs of 
production play an exceedingly important part in de- 
termining the values of goods. Commodities produced 
under competitive conditions tend to sell at cost; com- 
modities the production of which is controlled by monop- 
olies sell above cost, as a rule, but at prices which usu- 
ally stand in a close relation to the costs of production. 
In practical life, one rarely carries the analysis of value 
farther than this. Costs appear to the individual pro- 
ducer as something fairly definite and fixed, upon which 
he may safely base his calculations in deciding whether 
or not he shall enter a given Hne of business. 

From a business point of view the cost of producing a 
commodity or a service consists in the aggregate price 
of the commodities and services used up in the process 
of production. The greater part of the cost of most 
commodities is made up of the price of material, the 
price of labor, and the price of the use of the capital 
invested in plant. These prices the individual pro- 
ducer must, as a rule, accept as he finds them, just as 
he accepts the price of finished products as he finds it. 
We have seen that by increasing or reducing the volume 
of his production, the individual business man exerts a 
real, though imperceptible, influence upon the price of 

87 



88 INTRODUCTION TO ECONOMICS 

finished products. It is obvious, at the outset, that the 
individual business man must exert a like influence on 
the price of the commodities and services that enter into 
his production. If he extends his business, he must in- 
crease his demand for labor, machinery, and materials, 
and this cannot fail to affect the prices of these factors. 

2. The materials of production have market and 
normal prices governed by the same laws as 
the prices of finished products. 

We may examine briefly the process by which cotton 
yarn, the material of the cot ton- weaving industry, is 
valued. A multitude of weavers desire to buy it; some 
of them would pay a price of lo x per hundred pounds 
rather than go without it; others would pay only 
5 X per hundred pounds. A multitude of sellers stand 
ready to furnish cotton yarn; some may be willing to 
sell at 5 :r rather than not sell at all; others may be 
willing to sell only if the price is lo x. What price will 
actually be set? Just as in the case of commodities for 
direct use, the market price is fixed at a point where 
demand and supply are equal — that is, where the 
amount offered at a given price is exactly equal to the 
amount that will be taken at that price. 

But the price fixed at any moment by demand and 
supply may exceed the cost of producing the yarn, even 
in the mills of those enterprisers who produce at the 
greatest cost. In such case the output of cotton yarn 
increases, and the price falls until it just covers cost of 
production to those who are producing at the greatest 
disadvantage. If the price were to fall still lower, these 
producers would have to quit the business; and this 
would reduce supply and thus of itself tend to force up 
the price of cotton yarn. But the same price may be 
high enough to give excellent profits to the more efficient 
producers; these continue to extend their business, and 



THE COST OF PRODUCTION , 89 

the increase in supply from this source may be more 
than an offset for the decrease resulting from the closing 
of the less efhcient mills. Thus the price gravitates 
steadily downward, resting momentarily at cost of pro- 
duction to the least efhcient producers; then sinking to 
the cost level of sHghtly more efficient producers; finally 
resting at the level of cost of the most efficient pro- 
ducers of all. Thus it appears that we need no new 
law to explain the action of buyers and sellers of cotton 
yarn. They act just as they would if they were buying 
and selling a commodity ready for consumption. 

3. Fluctuations in the price of a product are re- 
flected, in greater or less degree, in the prices 
of materials employed in making the product. 

If, through a general increase in the demand for 
cotton fabrics, the price of cotton cloth everywhere rises, 
all the manufacturers of cloth at first enjoy a profit. 
To increase that profit each manufacturer tries to ex- 
tend his business, and this tends to bring down the 
price of cloth. But in order to extend the cotton cloth 
manufacture, more yarn must be had. The cloth manu- 
facturers are forced to bid against one another for the 
existing supply of yarn, and the price of yarn rises. 

We see, then, that it is not merely because of com- 
petition in the sale of finished products that such pro- 
ducts sell at cost; it is also because of competition in 
the purchase of the elements of production. If the price 
of cloth is for a time much above cost, the expansion 
of the cloth manufacture tends to lower the price of 
cloth and raise the price of yarn and other elements in 
cost, until the price of cloth and its cost are again nearly 
equal. 

Looking now at the manufacture of yarn, we see that 
such an increase in the price as we have assumed will 
result in high profits throughout the industry, and con- 



90 INTRODUCTION TO ECONOMICS 

sequently will give rise to an attempt on the part of 
each manufacturer of yarn to increase his output. But 
an expansion of the spinning industry involves an in- 
crease in the demand for raw cotton. And this tends to 
raise the price of raw cotton as well as to reduce the 
price of yarn. 

If, on the other hand, the price of cotton fabrics were 
to decline, we should see this decline reflected in the 
price of cotton yarn, and later in the price of raw 
cotton. High prices of finished products thus tend 
to produce high costs. Rise of costs, however, encounters 
an opposing tendency in increased production of the 
goods that make up costs. 

4. The bene fits of an increased demand for a 
finished product may rest permanently with 
the producers of the crudest materials that 
enter into that product. 

If the demand for steel rises, the steel manufacturer 
gains a profit, in the first instance. This benefit is 
soon passed on to the producer of pig iron, in the shape 
of a higher price for that product. An expansion of pig 
iron production follows, and this entails an increased de- 
mand and a higher price for ore. Thus increased cost 
deprives the pig iron producer of his profit, just as it 
deprived the steel manufacturer of his profit. The owner 
of ore mines can now demand a higher price for ore, as 
it is found in the mine. This ore has, strictly speaking, 
no cost; it is a free gift of nature. The owner of ore 
mines, therefore, cannot be compelled to surrender his 
gains to an antecedent producer. So long as the in- 
creased demand for steel exists, he enjoys the benefit 
of high ore prices, unless new mines are discovered to 
compete with him. 

The relation to the price of finished products of the 
price of crude materials, as they exist in nature, is 



THE COST OF PRODUCTION 91 

best illustrated by examples drawn from primitive con- 
ditions, where such materials first begin to bear a value. 
In a newly settled country, the cost of bricks would con- 
tain no element representing clay in the bank or trees on 
the hillside. It would consist solely in wages of labor 
employed in cutting and hauling the wood, in digging and 
mixing the clay and shaping the bricks, and in interest 
on capital invested in kilns and drying sheds, etc. Bricks 
might at a given time sell at a price in excess of these 
costs; but this would cause new brickworks to be erected, 
and the price of bricks would fall until bricks were selling 
at a price merely covering cost. 

As population increased, the demand for wood for 
brickmaking would increase, as would also the demand 
for wood for other purposes. In time the proprietor of- 
woodlands would see an end of the supply within easy 
distances, and would demand a price for wood in the 
tree. Here, then, would be a new element in the cost 
of bricks. Further growth of population might make 
the supplies of suitable clay insufficient to meet all 
demands, present ^nd prospective. The owner of clay 
deposits could therefore demand a royalty for every 
cubic yard of this material. If the demand for bricks 
continued to increase, the price of wood and of clay 
would steadily rise, and thus a constantly increasing 
proportion of the selling price of the bricks would be 
absorbed by the cost of the raw material. 

5. The price for the use of land, suitable for one 
product only, fluctuates with changes in the 
demand for its product. 

In some of the countries of North Europe are found 
extensive tide-marshes noted for the production of ex- 
ceedingly nutritious grasses. These lands cannot, without 
great expense, be put to any other use than that of 
producing forage. When the price of dairy products rises, 



92 INTRODUCTION TO ECONOMICS 

the rental of these lands rises; when the competition of 
inland districts forces down the price of dairy products, 
the rental declines. Owing to the influence of custom 
in maintaining ground rents at a fairly stationary level, 
the rental of such lands is likely to rise only after the 
higher level of dairy products has been established for 
a considerable period. But in time the value of the final 
product is inevitably reflected in the rental of the land. 

In most cases land may be put to a variety of uses. 
Corn land may be put under grass, fruit, or vegetables. 
The rental of corn land cannot fall below the probable 
rental that the land would yield under other crops. But 
often land is so peculiarly suited, by quality or by 
situation, for the production of a specific crop that the price 
of its use comes to depend upon that one crop alone. 

Let us suppose that a beet sugar manufactory is estab- 
Hshed somewhere in the heart of the wheat belt. Natu- 
rally, if a farmer wishes to rent a field upon which to 
grow sugar beets, he will have to pay' as high a rental 
as wheat growers in the vicinity pay for the same quahty 
of land. 

Beet growers may find, after paying all of the costs, that 
a considerable profit remains in their hands from the sale 
of their beets. In such case this form of culture will 
expand, and more and more wheat land will be devoted 
to the growing of beets. The increasing output of beets 
may conceivably reduce their price; but more probably, 
since an enormous increase in the sugar output of a given 
locality is yet a very small addition to the world's sugar 
supply, the price of beets will remain fairly constant. 
Accordingly, the expansion of the industry will continue 
until all the good lands within a reasonable distance from 
the factory are given over to this branch of agriculture. 
If the beet growers still have a surplus profit, they will 
compete among themselves for land, each desiring to in- 



THE COST OF PRODUCTION 93 

crease his acreage. Higher rents will be offered, until 
the extra profits of the enterpriser are absorbed by this 
increasing element in cost. If for any reason the price 
of sugar rises to a higher level, the rental of beet lands 
must also rise. 

6. Under certain conditions the wages of labor 
are intimately connected with the price of a 
particular product. 

Let us imagine that a new branch of production arises 
— say, the manufacture of wrapping paper from corn- 
stalks. A single factory is erected, and let us assume 
that it will be operated in the winter months only. The 
factory we may suppose is established in the country, 
near the source of raw material. And in the country 
there is a great deal of labor that is not employed in the 
winter months. At what rate will our manufacturer be 
able to hire this labor? 

Xt is clear that the cost of living will have nothing to 
do with the wages fixed. Country laborers are paid 
enough in the open months of the year to carry them 
through the winter. What they earn in the paper factory 
is a net addition to their annual income. They can work 
for nothing, and be no poorer than they were before the 
factory was erected. The work in the factory may be 
pleasant , rather than otherwise. Nevertheless, it is safe 
to assume that some rate of wages must be paid. Per- 
haps wages of fifty cents a day will provide the requisite 
amount of labor. If so, that is all the manufacturer 
will pay. 

Now, if the manufacturer gets his labor at such a low 
rate, he may make extraordinarily high profits. In this 
case other enterprisers are Hkely to go into the business. 
If the industry assumes extensive proportions, it soon 
drains off the supply of labor that can be had for fifty 
cents a day. Further expansion becomes possible only 



94 INTRODUCTION TO ECONOMICS 

through an increase in wages which will tempt into the 
industry workmen who regard their ease as worth more 
than fifty cents a day, or who are earning at least so 
much in caring for live-stock, etc. But profits may still 
be high, and new enterprisers may be continually entering 
the business. To secure laborers they are compelled to 
offer wages slightly higher than those paid by the enter- 
prisers whose business is already established. The latter, 
in order to retain their laborers, are compelled to meet 
the bids of their new competitors. Thus wages for this 
kind of work go up, until all the enterprisers are fully 
supplied with workmen. 

Any further expansion will be followed by a similar in- 
crease in competition among employers of labor, and a 
rise in the rate of wages will be necessary in order to 
induce less industrious workers, or workers having some 
alternative employment, to enter the factories. But each 
expansion of the industry means an increased prodiict 
thrown on the market, and, other things equal, a lower 
price for it. What with the rising of wages and the 
falling price of paper, it is clear that the profits of the 
enterpriser must decline. Possibly the expansion will 
continue until wages have risen to $3. All depends 
upon the amount of paper that will be taken at a given 
price, and the amount of labor available. 

7. The price of labor depends not only on the 
price of the finished product, hut also on the 
price of other factors in production. 

Let us assume that there is a city which has been 
devoted almost exclusively to the manufacture of iron and 
steel goods. A cotton manufacturer, visiting the city — 
Ironton, let us call it — shrewdly concludes that the iron 
worker must have a number of sisters and daughters 
and other female relatives, who are practically wasting 
their time, and who would be glad to earn a small income 



THE COST OF PRODUCTION 95 

by cotton spinning and weaving. Accordingly he erects 
a mill at Ironton. Possibly he will get all the labor he 
cares for at a dollar a day, while his competitors, in the 
established centers of the trade, are paying two dollars 
a day for the same grade of labor. In this case the cost 
of producing a given grade of cotton at Ironton may be 
twenty per cent lower than the cost of producing the 
same grade in the older centers, while the selHng price 
must be about the same since cottons are easily trans- 
ported from one center to another. Of course this will 
give the enterpriser at Ironton large profits. Before long 
other enterprisers will begin to inquire why a cotton 
mill has been set up at Ironton; and finding what ad- 
vantages that city offers in the way of low costs, they 
too will erect mills there. 

The effect of the appearance of these new manufac- 
tures at Ironton is to increase the demand for cheap 
labor. Possibly there are so many women and girls who 
are ready to work for ''pin money" that the new mills 
can be plentifully suppHed with labor at the same price 
that has been paid by the enterpriser first in the field. 
But it cannot be a great while before the supply of dollar 
labor falls short of- the demand; enterprisers erecting new 
mills will have to offer slightly higher wages to entice 
workers away from the older mills, and these will have 
to raise wages to the rate offered by the new comers. 
The competition will continue until wages are so high as 
to induce a new set of workers to enter the mills. Costs 
at Ironton may still be abnormally low after wages have 
risen, say, to a dollar and a half a day. In that case the 
cotton industry at Ironton will go on expanding, until 
at last aggregate costs are as great at Ironton as in the 
older centers of the trade. 

The point that here needs emphasis is that the com- 
petition of different centers equalizes, not wages cost, but 



96 INTRODUCTION TO ECONOMICS 

aggregate costs. Coal may be cheaper at Ironton than in 
other centers of the industry; mechanics' services in the 
erection of buildings and in the setting up and repair of 
machinery may also be cheaper. In such case cotton 
manufacturers at Ironton are not producing at cost even 
when the wages of textile laborers are as high as in other 
centers. There still remains a margin of profit, which 
leads to expansion of the industry and increased demand 
for labor. Under competition wages at Ironton must 
inevitably rise above the average in other centers. We 
may, therefore, formulate the principle that if competition 
exists among different producing centers, all supplying 
the same markets, wages in an industry in one center 
will rise or fall until, together with other costs of pro- 
duction, they equal wages plus other costs of production 
in the other centers where the industry is carried on. 
To give a numerical example: if in city A one hundred 
yards of cotton cloth cost $io, of which $S consist of 
cost of materials, fuel, interest on capital, etc., and $2 of 
wages; and if in city B, which obtains the same price 
for cloth at the mill, all other costs amount to only $7, 
wages in B will rise, under competition, until labor cost 
amounts to $3. 

Much attention has been given to the fact that in 
many branches of industry the American producer can 
meet the competition of the foreign producer, although 
the former pays higher wages than the latter. In many 
cases the personal efficiency of the American laborer is 
so much greater than that of the foreign laborer that 
wages cost, per unit of product, is less in this country 
than in foreign countries. Labor cost is thus higher 
only in appearance, not in reality. In other cases the 
low prices at which Americans can afford to sell are to 
be explained by the exceptionally low prices prevailing 
here for other cost factors — fuel, the use of land, etc. 



THE COST OF PRODUCTION 97 

8. The dependence of the price of cost gaods 
upon the price of finished products is usually 
obscured by the fact that most cost goods are 
demanded by more than one industry. 
In a large area of the Middle West, the soil is equally 
well adapted for the growing of corn and of wheat. If 
the price of wheat falls, the rent on land formerly used 
for wheat growing will not necessarily decline. The 
land will simply be taken over by corn culture, and con- 
tinue to yield the same rent. , Here it appears that the 
necessity of paying rent exerts a controlling influence on 
the supply of wheat, and hence on its price. The labor 
which can be used in farming can also be used for rail- 
way building and for much of the unskilled work in the 
cities. If, then, the prices of farm products decline, the 
wages of farm labor may decline only slightly, if at all, 
since any reduction in wages would drive laborers into 
other employments. In any single industry, the price 
of labor and of other cost goods is likely to be less sub- 
ject to the control of the men engaged in the industry 
than is the price of the products of the industry. To 
double the output of a particular grade of cotton cloth 
would, under ordinary circumstances, reduce its price very 
materially. The expansion of the production of this 
grade of cloth would represent an increased demand upon 
the supply of raw material, of labor, and of fuel. But 
this increase might represent less than one ten-thousandth 
of the total demand for these factors in production, and 
would consequently exert scarcely a perceptible influence 
upon their price. It is natural, then,, that practical men 
should regard costs as something fixed and independent 
of their control, while they regard the price of finished 
products as variable and dependent upon their action 
in producing or refraining from production. 

That costs follow prices, instead of determining them, 



98 INTRODUCTION TO ECONOMICS 

is seldom -evident at first glance in normal times. In 
times of great economic stress the principle is so obvious 
as to press itself upon the attention of even the most 
careless observer. In the second half year of the Great 
War, when the belligerent nations were importing vast 
quantities of industrial products and food supplies, prices 
in America set out on an upward course that continued 
until well after the close of the war. In most cases prices 
were doubled, in some trebled or even quadrupled, and 
very promptly costs began to rise. Wages doubled, even 
when there were no labor organizations to press for a rise; 
rents increased, the prices of coal and raw materials at- 
tained to higher levels than had ever been known. Then 
prices took a downward turn, with the post-war depres- 
sion. Wages and other items of cost followed painfully 
after prices. After so colossal a demonstration of the prin- 
ciple it might be supposed that no one would ever again 
suppose that money costs have the power of determining 
the level of prices. Yet since costs will continue to de- 
termine at what price a given enterpriser can produce, 
and since few men look far beyond their own business, 
it will soon be stoutly maintained by many intelligent 
persons that what determines price is cost of production. 
9. Where two centers of production compete freely 

with each other, the one may he able to drive 

the other out of certain lines of industry. 

The one cannot drive the other out of all lines 

of industry. 
It is often said that the South can manufacture cotton 
more cheaply than New England, and that therefore, 
since both sections must sell their products at practically 
the same price, cotton manufacture in New England is 
doomed. The advantages of the South are said to be 
cheaper labor and cheaper power. Let us see how long 
the advantages can be retained. 



THE COST OF PRODUCTION 99 

As the South extends its production, the price of cotton 
goods decUnes. Possibly some New England mills are 
forced to shut down; others, while continuing in opera- 
tion, reduce their output. The expansion of the industry 
in the South increases the demand for labor and tends to 
raise its price. The contraction of the industry in New 
England reduces the demand for labor, and tends to 
lower its price. Forces are therefore at work reducing 
the difference between the two centers in labor cost. 

But the wages of cotton operatives depend not only 
on the fortunes of the cotton industry, but on the for- 
tunes of other industries as well. A reduction in the 
wages of cotton mill hands in New England causes an 
efflux of such labor into other industries, and this tends 
to check the reduction in wages. In the South rising 
wages in the cotton industry is followed by an influx of 
laborers from other industries, and this tends to check 
the rise of wages. It is quite possible that, owing to the 
existence of other industries capable of absorbing labor 
on the one hand, or of yielding up labor on the other, the 
South will get a larger and larger share of the cotton 
industry, until it has taken over practically the whole 
business. 

Now let us suppose that all the industries of the South 
are in competition with all the industries of New Eng- 
land, and that costs are lower in the former part of the 
country than in the latter. An attempt on the part of all 
Southern producers to extend their outputs immediately 
forces up the price of all producers' goods — labor, fuel, 
and water power, etc. A tendency on the part of all New 
England producers to restrict production immediately re- 
duces the price of producers' goods. It is, then, only for 
a brief time that all costs can be higher in one section 
than in the other. The higher price of labor might in- 
deed induce the whole New England working population 



lOO INTRODUCTION TO ECONOMICS 

to migrate to the South; but in no other possible way 
could the volume of New England industry be perma- 
nently restricted by Southern competition. 

The same reasoning applies to international competi- 
tion. After the Great War there was much talk of the 
danger that German competition might destroy the indus- 
try of England, Belgium and even of the United States. 
There is no doubt that after the collapse of the German 
money standard, the cost of production in Germany fell 
far below that of the other industrial nations. Wages, 
rents, coal and raw materials of German origin were to be 
had at absurdly low prices, measured either in gold or in 
international purchasing power. But the condition was 
one that could not last, once international trade got well 
under way. The export demand for German goods was 
bound to raise their prices, and with this rise, to draw 
wages and other cost items to a higher level. At the 
same time German competition was bound to lower the 
prices of similar goods produced in other countries, and 
eventually to lower wages and other items of cost corre- 
spondingly. Much distress accompanies such a process of 
readjustment, but in the end it is inevitable that a new 
balance should be established, in which most staple ex- 
port goods are produced as cheaply in one country as 
in another. No nation can permanently enjoy the ad- 
vantage of general low costs, because the costs themselves 
are ultimately adjusted, in the case of export industries, 
to the international price level. 

10. Some costs manifest a more direct dependence 
on the price of particular finished products 
than do others. The former are therefore 
said to he price-determined; the latter are 
said to he price-determining. 
In the making of bricks, the laborers employed are for 
the most part of a kind equally well suited for farm labor 



THE COST OF PRODUCTION loi 

or for unskilled labor in the cities. The fuel used in 
burning the bricks might be put to a hundred other uses. 
The clay, on the other hand, can probably be used for 
nothing but for making bricks. 

Accordingly, if the price of bricks rises, this is not 
likely to affect the price of labor or of fuel. For the price 
of these goods is derived from a wide range of production 
in which they are employed, and the making of bricks 
represents a negligible part of the demand for them. It 
is entirely different with the price of clay. If the avail- 
able deposits are limited, this price may rise so high as to 
absorb practically the entire gains resulting from the rise 
in the price of bricks. If the price of bricks falls, the loss 
is borne chiefly by the owner of the clay deposit. 

In a country whose agriculture consists almost exclu- 
sively in wheat raising, a rise in the price of wheat will 
raise wages of farm hands only shghtly, as the rate of 
wages in agriculture must bear a close relation to the rate 
of wages in other unskilled pursuits. It will raise the rent 
of wheat lands, as the price of the use of such lands de- 
pends on their use for growing wheat, and on nothing else. 
It is easy, therefore, to see what the earlier economists 
meant when they said that rent is the effect, not the 
cause, of price. Rents, under certain conditions, rise or 
fall with the price of agricultural produce. Certain mod- 
ern economists express the same thought when they 
say that rents are price-determined. Wages were re- 
garded by earlier economists as the cause, not the effect, 
of price; they are said by some modern economists to be 
price-determining, not price-determined. As we have 
seen in the foregoing sections, a sufficiently broad view 
shows that the prices of all cost goods are derived from 
the prices of their products. And there are few cost goods 
so definitely restricted to a particular line of production 
that a reduction in their price in one industry does not 



I02 INTRODUCTION TO ECONOMICS 

result in a partial withdrawal of their supply, with a 
consequent reaction on price. 

11. Summary. 

Since prices normally bear a close relation to the costs 
of production, an ultimate explanation of prices involves 
an explanation of the forces determining costs. The 
general principle is that the prices of cost goods are de- 
rived from the prices of finished products. Accordingly, 
when the price of a finished product rises, this rise is re- 
flected first in the prices of those goods that enter into its 
production, and later in the prices of goods entering into 
the production of the cost goods. Under competition 
the benefits from a rise in the price of a finished com- 
modity rest ultimately with the factors in production 
that are Hmited in quantity, either by natural or by 
social-economic conditions. 

If a production good is used in a large number of indus- 
tries, a rise or fall in the price of any single commodity 
into which it enters will have little effect upon its price. 
For to reduce the price of the production good in one in- 
dustry would result in diverting it to other industries. A 
condition of producing a finished commodity is a price 
sufficient to pay the usual rate for production goods of 
this kind. Such goods are therefore in a price-determining 
position. The production goods which can be used in 
only one industry rise or fall in price with the products 
of that industry. 



CHAPTER VI 
THE LAW OF DIMINISHING RETURNS 

1. Increase in the output of an industry is nor- 
mally checked by increase in the cost of some 
factor in production, due to the difficulty en* 
countered in increasing the supply of that 
factor. 

In the last chapter we saw that one of the forces limit- 
ing the expansion of an industry is the tendency of costs 
to rise to the selling price of the product of the industry. 
The American cotton-spinning industry may be very prof- 
itable one year — that is, the margin between the selHng 
price of cotton yarn and the cost of producing it may be 
wide. But before long an expansion of the industry takes 
place; increasing demands upon the existing supply of 
skilled labor, of raw cotton, and of other factors in the 
production of cotton yarn force the expenses of the enter- 
prisers engaged in the industry to a higher level. 

We saw further that not all elements in cost show the 
same tendency to increase. In cotton spinning, part of 
the labor force is skilled, part of it unskilled. If the in- 
dustry were to expand, say, by fifty per cent, a great 
strain would be put upon the supply of labor specially 
trained for cotton spinning. No perceptible strain would 
be placed upon the supply of unskilled labor, for outside 
of the spinning industry enormous quantities of unskilled 
labor are to be had. The skilled labor might therefore 
for a time enjoy a large increase in wages, while the wages 
of unskilled labor would scarcely be affected at all. 

103 



104 INTRODUCTION TO ECONOMICS 

Similarly, such an expansion of the industry would 
represent a great strain upon the supply of raw cotton, 
which for a year could not be increased. Quite possibly 
the price of raw cotton would be doubled. The same 
expansion of the cotton-spinning industry would result in 
an increased demand for coal for power. But the use of 
coal is so universal, and the volume of its consumption so 
vast, that the increased demand from the cotton industry 
would be a negligible factor in influencing its price. Coal 
would probably not rise perceptibly. 

2. The individual enterpriser usually finds him- 
self hampered in his efforts to increase his 
business by the difficulty of increasing his 
supply of some of the factors entering into 
his production. 
For a somewhat different reason, the output of a single 
enterpriser can often be increased only at increasing cost. 
It is true that one enterpriser out of a multitude cannot 
force up the wages of labor against himself, as a whole in- 
dustry can do. Nor can he exertany perceptible infl- 
uence upon the price of raw material and other suppHes. 
But there are usually certain factors entering into his pro- 
duction that, so far as he is concerned, are either limited 
absolutely, or can be increased only at a disproportion- 
ately heavy outlay. In any agricultural section you may 
find an enterprising farmer forced to limit his operations 
to a single hundred acres. He can hire as many men as 
he pleases at $40 a month, the price he pays his one 
''hired hand." He can buy additional teams and addi- 
tional machinery at no advance over the price of those he 
already has. Why does he not buy or rent- additional 
land, and carry on a large scale business? Because all 
the adjoining lands are occupied by men who prefer to 
till them with their own labor and who would conse- 
sequently demand a very high rental, if they consented to 



THE LAW OF DIMINISHING RETURNS 105 

give up their land. Our farmer might be compelled to go 
a distance of three or four miles to get additional land at 
reasonable rates. Of course land cannot be advantage- 
ously cultivated from such a distance. Hence the farmer is 
forced to content himself with his own one hundred 
acres. 

In almost any town you may find a bright and capable 
young grocer, conducting the pettiest corner grocery busi- 
ness. The possibilities of trade may be numerous; a store 
ten times as large might easily be supported by the po- 
tential custom. Why then do we find a little store? The 
young merchant might easily rent larger premises, with- 
out more than a proportionate increase in rent. He might 
hire as many clerks and delivery boys as he wished, 
without paying a rate of wages in excess of the rate he 
pays to the one or two already in his employ. What he 
especially lacks is capital. Perhaps he has $5000 of his 
own. The cost which the use of this capital represents 
is merely the interest he could get at a savings bank — 
say, four per cent. With $5000 capital of his own, he 
may be able to borrow another $5000 at six per cent. For 
an additional $5000 he would probably have to pay ten 
per cent, as the security he has to offer is not so good. 
It is unlikely that he can borrow more capital, no matter 
how high a rate of interest he may be willing to pay. 
The maximum business he can conduct, then, is one for 
which a capital of $15,000 will suffice. 

A small stream, flowing between high, rocky banks, 
may offer an excellent opportunity for the establishment 
of a factory to be operated by water power. Let us sup- 
pose that a manufacturer, acquainted with the advan- 
tages of the location, decides to erect a mill. He may be 
able to command practically unlimited capital. Whether 
his mill will require one hundred hands or one thousand 
will make no difference in the rate of wages he will have 



io6 INTRODUCTION TO ECONOMICS 

to pay. Raw material can be obtained at least as cheaply 
in large lots as in small. Plainly, what will determine the 
size of the factory will be the power to be obtained from 
the stream. A ten-foot dam will give a certain power; 
a twenty-foot dam a much greater one, and every addi- 
tional foot in height of dam means additional power. 
But there is an absolute limit to the height to which the 
dam may reach, without forcing the stream above its 
banks and ruining a large amount of property on the 
lower levels adjacent to it. There may also be limits of 
expense; after the dam has reached a height of twenty 
feet, a further addition to its height may imply such a 
great increase in its length and in the character of the 
materials required to stand the increased strain that the 
additional power is not worth its cost. 

It will not be necessary to multiply instances further. 
If the reader will examine the various businesses with 
which he is acquainted, he will observe that in a large 
proportion of them it is difficult, if not impossible, to 
duplicate some of the elements in production without in- 
curring disproportionate expense. 

3. In some cases an absolute limit is placed upon 
production when one of the factors cannot he 
increased in amount. In most cases, by the 
application of increased amounts of the other 
factors, production may be increased, but with 
constantly greater difficulty. 
Among the products of industry are many chemical 
compounds, the components of which are combined in 
perfectly definite proportions. A shortage of fifty per 
cent in the supply of any component entails a shortage of 
fifty per cent in the finished product. In most cases, 
however, the producer can vary the proportions in which 
economic elements in production are combined. A 
bushel of wheat may be produced on a relatively large 



THE LAW OF DIMINISHING RETURNS 107 

area with the appKcation of a small amount of labor, or 
on a relatively small area with the application of a large 
amount of labor. Cotton cloth may be woven with rela- 
tively small expenditure for labor and large expenditure 
for power and machinery, or with large expenditure for 
labor and small expenditure for power and machinery. 
Even a slight acquaintance with actual business condi- 
tions gives ample illustration of the fact that in every in- 
dustry there is great variety in the proportions in which 
the various producing factors are combined. Accordingly, 
if a business man is confined to a limited supply of one 
factor, he may yet increase his operations by selecting a 
method which involves small use of the limited factor 
and large use of the other factors. 

4. An increase in the amount of labor and auxi- 
liary capital employed upon a given area of 
land does not, as a rule, result in proportion- 
ate increase in product. 
Let us return now to the case of the farmer, confined to 
his one hundred acres of tillable land. By his own labor 
and with a single team and the appropriate machinery he 
may till the whole tract. Fifty acres, we may assume, are 
put into wheat, fifty acres into corn. In the time for 
sowing wheat, a few good days may be followed by a 
week of rainy weather. Half of the wheat field may be 
sowed in time to get the benefit of the wet weather; the 
other half of the field may have to be left until the 
ground is dry, and so this part of the crop will lose the 
advantage of an early start. Similarly, part of the corn 
planting may be belated, with resultiant danger to the crop 
from early frosts. There may not be enough dry days in 
the late spring to enable the farmer to keep his cornfield 
free from weeds. In harvest time, the chances of loss 
from delays in cutting and stacking the wheat are still 
greater. Of course these adverse chances may not be re- 



io8 INTRODUCTION TO ECONOMICS 

alized. "The weather may be dry just when it should be; 
the rains may come just when they are wanted. But ex- 
perience proves that the weather is not thus happily 
regulated." One year with another, our farmer will be 
fortunate if he gets twelve bushels of wheat and forty 
bushels of corn per acre. 

Instead of tilling the whole tract with his own labor, 
the farmer may hire a man to help him. He buys an 
additional team, plow, harrow, cultivator, etc., practically 
duplicating his stock of machinery as well as his supply of 
labor. The land can now be much more carefully tilled; 
it will almost surely yield a greater aggregate return. 
Will the return be doubled? It would be unreasonable to 
expect this. More probably, the wheat yield will increase 
to fifteen bushels; the corn yield, to fifty bushels. 

Now let us imagine that the farmer employs a second 
hired laborer, and invests an additional $500 in a team 
and machinery. How much will be added to the crop? 
It is unHkely that the addition will be as great as that 
resulting from the employment of the first hired work- 
man. We will assume that the wheat crop per acre is 
increased to seventeen bushels, the corn crop to fifty-five. 
With a third hand the crop of wheat would perhaps in- 
crease to eighteen bushels, and the crop of corn to fifty- 
eight. A fourth hand might increase the crop of wheat 
to eighteen and one-half bushels; that of corn, to fifty- 
nine bushels. There is no reason why every additional 
workman should not make some small addition to the 
crop, until the wheat crop had become fifty bushels and 
the corn crop one hundred and fifty. 

An important principle, involved in this example, may 
now be stated. From a given area of ground, an amount 
of produce can be obtained increasing with every increase 
in the labor and auxihary capital employed in tillage, but 
increasing less than proportionally with the increase in 



THE LAW OF DIMINISHING RETURNS 109 

labor and auxiliary capital. This principle is called the 
law of diminishing returns in agriculture. 

5. Returns diminish more rapidly in some branches 

of agriculture than in other branches. 
Some crops are far more responsive to the efforts of the 
husbandman than are others. If a wheat field is well fer- 
tiHzed and properly prepared to receive the seed, it may 
yield twenty-five bushels per acre. An American farmer 
would find it next to impossible to raise the yield to forty 
bushels, even at the expenditure of almost unlimited 
pains. A similar field, prepared in the ordinary manner, 
may yield fifty bushels of potatoes per acre. By extreme 
care in selecting the seed and in keeping the field free 
from weeds and from insects the yield might possibly be 
raised to two hundred bushels, or even much more. It 
is more feasible to quadruple the potato crop than to 
double the wheat crop. In the production of many 
garden vegetables and small fruits, the returns to extraor- 
dinary care are often almost incredible. Indeed, it has 
sometimes even been doubted whether the law of diminish- 
ing returns is operative in the growing of such products. 
There can be no doubt that doubling the amount of labor 
expended upon a given area in gardening often increases 
the output by more than one hundred per cent. But it is 
self-evident that a point must eventually be reached 
where a doubling of the expenditure for labor will fail to 
double the output. 

6. // the amount of capital expended in improv- 

ing a given urban building site is increased, 
the returns do not increase proportionately 
with the increase in capital. 
The principle of diminishing returns, as it operates in 
agriculture, was first formulated by economists more than 
a hundred years ago, although practical men have, of 
course, taken account of it in their business conduct ever 



no INTRODUCTION TO ECONOMICS 

since agriculture became man's chief source of food. The 
applicability of the principle to land devoted to trading 
and manufacturing purposes was for a long time ignored 
by economists. This may be explained by the fact that 
formerly urban land was so cheap that the small amount 
required for the erection of a shop or a factory represented 
an almost negligible element in the total costs of carrying 
on a business of this nature. The enterpriser rarely found 
himself forced to adjust his business with a view to ob- 
taining the greatest possible use from a definite amount 
of land. If his capital sufficed for so large a business, he 
purchased or leased a city block on which to erect his 
buildings; if his capital was small, he limited his use of 
land to a few lots. To-day conditions have changed, in 
consequence of the extraordinary growth of the cities. 
The merchant who desires to carry on a business in the 
heart of the business district of a great city often finds 
himself restricted to a given number of front feet. The 
adjacent lots are taken up by establishments which show 
no disposition to remove. It is then a question how to 
conduct a maximum paying business upon a fixed ground 
space. 

One way of overcoming the limitation of ground space 
consists in erecting a very lofty building. Instead of con- 
tenting himself with a building of six stories, the enter- 
priser may push the height to fifteen or more. Perhaps 
it costs $600,000 to erect a six-story building. An ad- 
ditional $100,000 may possibly give another story; but 
more probably the seventh story will, in effect, cost more 
than this. To raise the building materials to this height 
is more expensive than to raise materials to a lower story. 
Moreover, a seven-story building is not merely a six-story 
one with a floor superadded; in planning the taller build- 
ing, it is necessary to allow for greater strength of wall in 
the lower stories, in view of the additional weight to be 



THE LAW OF DIMINISHING RETURNS ii-i 

borne by them. Greater care must be exercised to reduce 
risk from fire. In addition to the increased cost of con- 
stuction. there will be greater costs in connection with 
the permanent use of the seventh floor than in connection 
with the use of lower floors. More labor will be spent in 
carrying up the goods to be exposed for sale, and in carry- 
ing down the articles sold. More numerous and more 
powerful elevators will be required for the higher build- 
ing. We may therefore place the initial cost of the addi- 
tional floor at $120,000. 

An eighth floor would, in effect, cost still more than the 
seventh — $140,000, let us say. A ninth floor may cost 
$160,000; a tenth floor $180,000, and the fifteenth floor 
may cost $280,000. As there is no reason for supposing 
that the higher floors will accommodate more business 
than the lower, it is clear that the returns on capital 
invested diminish with each additional floor. 

7. The principle of diminishing returns is illus- 
trated by the results of increasing the rolling 
stock of a transportation company without 
increasing trackage. 

In a certain city a street railway company, let us as- 
sume, has extended its lines of track through all the 
streets which promise any considerable traffic. The 
trackage is then a fixed element in the company's busi- 
ness, analogous to the land of the farmer or the floor 
space of the merchant. The variable elements are labor, 
fuel for power, and auxiliary capital in the shape of cars. 

With one hundred cars in the entire system, running at 
intervals of twenty minutes, the company may carry an 
average of one hundred passengers per car per trip, thus 
earning $5. It is easy to see that the number of pas- 
sengers carried would be increased if the service were 
more frequent. Persons who have only a short distance 
to go will form the habit of walking, if the alternative 



112 INTRODUCTION TO ECONOMICS 

usually means waiting fifteen or twenty minutes for an 
overcrowded car. Quite possibly the company would get 
twice as many fares with two hundred cars, running at 
intervals of ten minutes. In this case the tendency of 
returns to diminish does not appear. 

Imagine now that the company places a third hundred 
cars upon its lines, still further reducing the intervals be- 
tween cars. In large measure these cars will simply carry 
passengers who would have been carried by the other 
cars; and this is, of course, no gain to the company. The 
greater efficiency of the system, and the greater comfort 
of riding in cars that are never overcrowded, will develop 
some increase in traffic. Possibly this increase will 
amount to fifty passengers for each of the new cars. 
Each of the new cars would thus represent an addition 
of $2.50 to the income of the company. An additional 
hundred cars may increase the number of passengers 
carried by an average of twenty-five for each additional 
car; still another hundred may increase the number of 
passengers carried scarcely at all. 

8. The principle of diminishing returns comes 
into operation when the amount of labor in- 
creases, while the amount of capital remains 
fixed. 

The element in production which operates to limit the 
expansion of a given business may be capital in its general 
form, not any concrete productive good. It is a fortunate 
business man who finds his capital limited only by the. 
possibilities of profitable employment which he com- 
mands. In practical life a man can secure for use in his 
business, besides his own capital, only the additional 
capital for which he can give security. And this is usually 
limited to some proportion of the value of his own pro- 
perty. 

Assuming that a manufacturer possesses a capital of 



THE LAW OF DIMINISHING RETURNS 115 

$50,000, and can borrow $50,000 more, the sum $100,000 
limits his operations as narrowly as any other fixed ele- 
ment in his production could do. He has, of course, 
many choices as to the exact disposition of the capital. 
If he is engaged in cotton manufacture, he may use first- 
class machinery, or he may employ a poor grade of 
machines — perhaps machines that have been discarded 
in other sections, as was for a long time a common prac- 
tice in the South. He may decide upon investing $50,000 
of his capital in looms, and the remainder partly in the 
building and partly in materials, etc. With twenty-five 
laborers and high-grade looms, the output per laborer 
will be high; with fifty laborers and lower grade looms, 
the output per laborer will probably be less, although the 
total output of the mill will be increased. A third force 
of twenty-five laborers with a still cheaper grade of looms 
will add something to the total output, but the output 
per man will be still further diminished. Perhaps the 
output per man, when twenty-five are employed, will be 
$2000. With cheaper looms and fifty men, the output 
per man may be $1900. Seventy-five men, with the cap- 
ital put into appropriate form, might produce $1800 per 
man. With one hundred men, the returns per man 
might be $1700, and with each further addition to the 
number of men a corresponding decrease in product pqr 
man might take place, until at last additional laborers 
added nothing to the output. 

9. The principle of diminishing returns is of uni- 
versal application in the field of production. 

Wherever one element in production is fixed, while the 
other factors in production increase, the principle of 
diminishing returns inevitably operates. Wherever one 
factor in production increases, while the other factors in- 
crease at a more rapid rate, the law of diminishing re- 
turns operates, but in modified form. If the labor and 



114 INTRODUCTION TO ECONOMICS 

movable capital of society increase while the natural re- 
sources at the command of society fail to increase, dimin- 
ishing returns appear, as in the individual establish- 
ments of our examples. 

We may now state the law of diminishing returns in its 
general form. When any one of the several factors whose 
cooperation is essential to production is limited in quan- 
tity, either absolutely, or hy conditions of increasing cost, 
while the quantity of the other factors may he increased 
practically without limit, every unit of increase in the 
variable factors results in an increase of output less than 
proportionate to the increase in the variable factors. 

10. Economy in production is at its maximum 
when the final expenditure on the variable 
factors just equals the return to those factors. 

The manufacturer who erects a mill to utilize the 
power obtained by damming a stream, is limited in his 
operations by the power represented by the head of 
water. This is the fundamental limiting element in his 
calculations. But it is not to be supposed that the power 
which he will actually obtain is a definitely fixed quan- 
tity. Human ingenuity has devised no means whereby all 
the power actually resident in any natural source may 
be transmuted into a form which lends itself to use. 
AJl our devices for securing and transmitting power are 
imperfect; the best of them are only less wasteful of 
energy than the worst. Our manufacturer may install 
a mechanism which costs little but permits a large part 
of the power to go to waste, or he may install a more 
complicated and costly set of devices, which will come 
far nearer turning to account the whole power repre- 
sented by the fall. We may think of the manufacturer 
as weighing the advantages of different kinds of power 
plant. The expenditure of $1000 will permit the utiliza- 
tion of, perhaps, one half of the power. A second 



THE LAW OF DIMINISHING RETURNS 115 

$1000 may make it possible to utilize two thirds of the 
power. With a plant costing $3000 perhaps three fourths 
of the total power will be utilized. A $4000 plant may 
utilize four fifths of the power, and so on. At what 
point will it be more profitable to let power go to waste 
than to incur additional expense to save it? One half 
of the power may have a value of $300 per year. Inter- 
est and depreciation on the $1000 necessary to obtain 
this power may amount to $150. The value of the power 
which would be obtained through the $2000 plant, on the 
basis we have assumed, would be $400; and the cost, 
figuring interest and depreciation as before, would be $300. 
The simple plant therefore would yield a net value of 
$150 above cost; while the more complicated plant would 
yield only $100. It would accordingly pay best to install 
the $1000 plant. If the value of the power should 
double, however, while the cost of the several kinds of 
power installations remained unchanged, the $1000 plant 
would yield a value of $600 at a cost of $150, leaving a 
net gain of $450; while the $2000 plant would give a 
power worth $800 at a cost of $300, leaving a net gain 
of $500. 

The $3000 plant would yield a power worth $900, but 
at a cost of $450. The net gain is evidently diminished 
through the installation of the $3000 plant. The $2000 
plant is, under the circumstances, the most economical 
available. Were the value of the power again doubled, 
the $3000 plant would yield the highest surplus above 
cost, and so would be the most advantageous 
economically. 

Under present conditions it is an excellent steam engine 
which transforms into mechanical power one sixth of 
the energy of the coal which it consumes. A simple and 
inexpensive type of engine does not do nearly so well as 
this. At a given place and time, will it be more econom- 



ii6 INTRODUCTION TO ECONOMICS 

ical to employ an engine of the very highest type, and 
which naturally is very costly, or an inexpensive engine 
of a simple type? The former may transform into 
power fifteen per cent of the energy latent in the coal; 
the latter, only five per cent. If the additional power 
obtained through the better engine does not equal the 
excess of interest and depreciation charge on the more 
costly engine, the simpler engine is the more economical 
in spite of its wastefulness from the mechanical point of 
view. 

A farmer should continue his application of labor and 
capital to land as long as the returns from additional units 
of labor and capital exceed their cost. If wages and 
interest decline, it becomes possible to increase the appli- 
cation of labor and capital to land without passing be- 
yond the bounds of economical production. Similarly, 
Cultivation may profitably be made more intensive if 
the prices of agricultural products rise. We have here 
an explanation of the fact that in old countries land is 
cultivated more intensively than in new countries. In 
the latter wages and interest are high and prices are 
low. 

11. The law of diminishing returns may he 
counteracted by improvements in production. 

Improvements in methods of production are con- 
stantly taking place, with the result that a given amount 
of labor or of capital increases in efhciency. If the 
amount of labor employed upon a hundred-acre field 
increases, the increase in product will not ordinarily be 
proportionate to the increase in labor. But if at the 
same time a new way of cultivating or fertilizing the 
soil is discovered, or if the quality of the seed is im- 
proved, the product may very well increase relatively to 
the amount of labor. This fact does not prove that the 
law of diminishing returns is non-existent. It merely 



THE LAW OF DIMINISHING RETURNS 117 

proves that there are other forces at work which may, 
at times, neutrahze its effects. These forces are, of 
course, of the greatest practical importance, and will 
later demand our attention. 

Another quahfication of the principle of diminishing 
returns consists in the fact that the very process of in- 
creasing the number of units of variable factDrs employed 
in connection with an unvarying factor may, under cer- 
tain conditions, increase the productive efi&ciency of each 
unit of the varying factors. To employ two men on an 
acre of land that could be cultivated by one would result 
in a diminished return per man if each worked alone. But 
many tasks may be better performed when two or more 
men cooperate than when each works by himself. Ac- 
cordingly, it may happen that an increase in labor which 
makes cooperation possible, or an increase in capital 
which makes possible better methods, may be accom- 
panied by increasing, instead of diminishing, returns. 

12. Summary. 

In most businesses the enterpriser is subject to definite 
limitations in his control over one or more of the factors 
upon which his production is based, while he may be 
able to increase other factors without assignable limits. 
Such limitations upon some of the factors in a productive 
combination do not necessarily place an absolute limit 
upon the size of a business; they do, however, imply 
that after a certain size has been reached, further ex- 
pansion involves disproportionate expense. This prin- 
ciple, known as the law of diminishing returns, is of 
universal applicability in the field of production. 

The greatest economy in production is attained when 
the returns to the last units of the variable factors in a 
business just equal the cost of those factors. Every 
reduction in the cost of one of the variable factors 
extends the scope of profitable application of that factor. 



Ii8 INTRODUCTION TO ECONOMICS 

The law of diminishing returns may often be counter- 
acted by improvements in production; in some cases 
this counteracting influence may be brought about by 
the very forces that tend to bring the law of diminishing 
returns . into operation. 



CHAPTER VII 
THE SPECULIZATION OF ECONOMIC FUNCTIONS 

1. In primitive conditions all the functions of 
wealth production are performed by the single 
kinship group, or family. 

At the dawn of civilization men lived in small groups 
that were practically self-sufficing. Whatever work was 
to be done was executed by all the men in cooperation, 
or by any member of the tribe indifferently. There was 
naturally a distinction between the work of men and that 
of women; the former were in many cases engaged chiefly 
in hunting, the latter in root grubbing and in a primitive 
form of gardening. Economic differentiation, then, hardly 
existed. It is true that there was little occasion for the 
specialization of economic functions, since wants were few 
and economic functions were consequently simple. 

In many cases civilized men have been placed in con- 
ditions that bear a superficial resemblance to those of 
primitive life. But the civilized man carries with him a 
great number of wants that the savage never experienced. 
We therefore find, in such conditions, a progress in the 
differentiation of economic functions taking place in a 
few decades, while, in the history of the human race as 
a whole, differentiation was the result of thousands of 
years of development. 

In a frontier community, where almost the entire popu- 
lation consists of independent families living upon farms, 
the economic functions performed by each person are 
numerous and diverse. The frontiersman must, in the 

119 



I20 INTRODUCTION TO ECONOMICS 

first place, be an agriculturist and a grazier. Each of 
these occupations includes numerous functions calling for 
different qualities, the agriculturist being a plowman, 
sower, reaper, etc. The frontiersman must also be a 
woodcutter at times, a carpenter, a mason, a cabinet- 
maker, a smith, a butcher, and a hunter, not to speak of 
a host of miscellaneous functions that he must occa- 
sionally perform. His wife probably has a no less varied 
array of occupations. She is a cook, a laundress, a 
seamstress, a nurse, a teacher and even a spinner and 
weaver. To survive on the frontier one must be a jack 
of all trades. And practically the same range of duties 
falls upon the strong and the weak, the intelligent and 
the dull, the man who quickly acquires skill and the man 
who acquires it with great difhculty. 

2. The first stage in the differentiation of econ- ■ 

omic functions is the exchange of services. 

Were the frontier community wholly isolated for many 
generations, a transformation of its methods of production 
would gradually take place. A person with more than the 
ordinary talent for building would be called upon to assist 
in the construction of his neighbors' houses, receiving in 
return assistance in work for which he had no special 
qualification. Little by httle, occupations would be 
differentiated, and eventually the community would con- 
tain among its population carpenters, smiths, masons, 
weavers, etc. While these craftsmen might still own 
land, and spend their odd hours in agriculture, the main 
source of their livelihood would be the exercise of their 
several crafts. Specialization in the form known as 
differentiation of occupations would thus have come into 
existence. 

So long as differentiation of functions rests upon a 
direct exchange of services, it cannot be carried far. 
A cobbler may need a gate built, but it is not a simple 



SPECIALIZATION OF ECONOMIC FUNCTIONS 121 

matter to find a carpenter willing to take his pay in 
shoes. A scheme of payments based on an accepted 
medium of exchange is requisite. Moreover, differenti- 
ation of functions presupposes a considerable number of 
people in easy communication with one another. Popu- 
lation would need to be fairly dense before a man could 
devote himself exclusively to the building of houses, even 
if he undertook the work of stone mason, brick mason, 
and plasterer in addition to that of carpenter. Such 
trades as that of locksmith could hardly exist at all, 
since a scattered rural population could not furnish work 
enough to maintain it. 

3. An important step in the direction of economic 
specialization was taken when men began to 
produce commodities for sale. 

In early modern times the development of trade gradu- 
ally transformed production for the household or for the 
immediate neighborhood group into production for the 
general market. This change first attracted attention 
in the woolen industry. At first, we may suppose, 
only the surplus of domestic production was placed upon 
the market of the town, or carried to fairs where a 
larger concourse of purchasers was to be found. In 
time production for domestic use became a mere 
incident; the weaver came to depend on more or less 
distant markets for the sale of his wares. And this 
implied the purchase in the market of the materials of 
production. So we find German weavers in the fif- 
teenth century carrying their wool from England and 
their finished products to southern and eastern Europe. 
Under these conditions there was no reason why a man 
should produce more than one kind of cloth. A great 
body of consumers was within his reach, and however 
special his product, he could devote himself exclusively 
to it. 



122 INTRODUCTION TO ECONOMICS 

In like manner, traders would soon appear in the fron- 
tier community of our example in the last section and 
carry away the lighter surplus products, giving in ex- 
change the manufactured goods of older communities. A 
railroad would, in time, transform the frontier community 
into an integral part of the civiUzed world. Instead of 
weaving its own cloth, it would barter its surplus prod- 
ucts of the soil for textiles produced in other parts of 
the world. The community as a whole would thus be 
specialized to the functions best adapted to its conditions. 

As the community advanced in numbers and wealth 
one function after another would be taken out of the 
province of the man of all work, and given over to per- 
sons specially qualified by nature and training to perform 
it effectively. Each trade, again, would tend to sub- 
divide. The carpenter would no longer plan the building 
upon which he worked, this function being given over to 
the architect. The planing of boards would cease to be a 
part of the carpenter's work, as planing mills would be 
established which would do the work far more economi- 
cally. Even in agriculture some differentiation would take 
place; one man would devote himself chiefly to the grow- 
ing of grain, another to dairying or market gardening. 
Owing to the seasonal character of agricultural labor, 
however, and the advantages of combining crops in 
such a way that the work may be distributed as evenly 
as possible throughout the open months, specialization 
in agriculture could not be carried very far. Indeed, 
even in the best developed agriculture, we do not often 
find some farmers wholly devoted to wheat culture, others 
growing nothing but corn, others potatoes or turnips. 
Agriculture by its nature precludes a high degree of 
differentiation of functions. 



SPECIALIZATION OF ECONOMIC FUNCTIONS 123 

4. Differentiation of function in production is in 
large measure dependent upon the character 
of the existing commercial organization. 

In the mediaeval towns the artisan was at the same 
time a trader. He was compelled to supply himself with 
materials, often from distant sources; he was often com- 
pelled to carry his wares from place to place in order to 
find purchasers. The risks incident to procuring materi- 
als and marketing products weighed heavily upon him. 
Cooperation, as in the German Hanse towns, reduced his 
difficulties in some measure; nevertheless, under the 
conditions, comparatively few men could rely for their 
subsistence upon a single occupation. With the develop- 
ment of a merchant class, the producer was relieved of 
the labor and risks of assembling materials and market- 
ing products. The accumulation of large and perma- 
nent stocks of material gave occasion for a constantly 
increasing number of occupations and subdivisions of 
occupations. 

As an illustration of the effect of commercial develop- 
ment upon the division of labor, we may cite the in- 
dustry of shoe manufacture. One hundred years ago 
shoe making was carried on by independent cobblers, 
supplying a local demand. Every cobbler made many 
types of boots and shoes. At a somewhat later period, 
shoes had become an article of commerce, and the cobbler 
ceased to be dependent on the local demand. In the next 
stage in the process of development, the commercial de- 
mand for shoes had become too important to allow the 
supply to remain dependent upon the enterprise of the 
independent cobbler.' The merchant began to furnish 
material ready cut to be sewed and pegged by persons 
capable of doing the work, whether trained in the cob- 
bler's trade or not. In this stage the simpler processes 
were performed by one set of hands, the more compli- 



124 INTRODUCTION TO ECONOMICS 

cated by another. Thus division of labor had succeeded 
differentiation of occupations. Further improvements in 
methods of marketing the finished product led to still 
more minute division of labor, under the factory form 
of organization. To-day each shoe goes through scores 
of hands before it is placed on the market as a finished 
product. 

A similar evolution may be traced in the ready-made 
clothing industry — a still newer field. The retail and 
wholesale clothing trade has grown up in the last sev- 
enty-five years; its increasing demands have given a 
stimulus to the differentiation of functions in the making 
of clothes. It is, of course, to be borne in mind that in 
all cases the development of trade and the differentiation 
of economic functions have proceeded concurrently. Each 
has been in part the effect, in part the cause, of the other. 

5. Improvements in transportation give occasion 
to increased specialization in industry. 

Division of labor first reached a high degree of develop- 
ment in centers enjoying water transportation. Until 
recent times, it was only at such centers that the more 
bulky materials of industry could be assembled in suffi- 
ciently large quantities to permit extensive subdivision 
of functions; furthermore, it was only from such centers 
that it was possible to carry bulky goods to a great 
number of consumers. The advent of the railway en- 
abled inland cities to engage in highly specialized pro- 
duction. As railway service became better and cheaper, 
many forms of industry permitting a minute division of 
labor appeared. Until refrigeration had been reduced to 
a science, and the methods of transporting products 
preserved by ice had been perfected, every locality de- 
pended for its supply of meat upon the local butcher. 
If the consumers in the vicinity were few, they were 
ordinarily supplied by small shops which permitted only 



SPECIALIZATION OF ECONOMIC FUNCTIONS 125 

a low degree of division of labor. In the cities, the shops 
were larger, and division of labor was carried farther. 
To-day there is almost no Hmit to the market for a 
single establishment. Fresh meats from Chicago may be 
found in any city or town in the land. Fresh mutton 
killed in New Zealand and Australia finds a ready market 
in England. The parallel development of live stock trans- 
portation has given the slaughtering centers a practically 
unlimited supply of raw material. Accordingly, a minute 
division of labor has been evolved in the slaughterhouses. 
In the Chicago slaughterhouses the killing and dressing 
of a bullock is subdivided into fifty or sixty separate 
functions, each assigned to a separate set of workmen. 
Each set makes some small change in the material and 
passes it on to another set. Of course some functions 
are performed by single workmen, some by several. The 
laborers are organized in gangs of over 200 men, each 
gang containing just the appropriate number of men of 
each class. 

6. In the field of production at the order of the 
consumer, division of labor is dependent 
largely upon the density of population. 
Where the producer of a commodity deals directly 
with the consumer, the opportunity for minute division 
of labor is not so great as where the producer is brought 
into relation with the consumer through the intermedia- 
tion of a general market. The amount of work that may 
be secured by a single custom-tailor's shop is Hmited by 
the number of purchasers of custom-made garments 
within easy distance. In a village this number may be 
so small that anything Hke subdivision of the tailor's 
trade is impracticable. In a large city the case is dif- 
ferent. A single shop may easily find customers enough 
to keep twenty men at work. In the latter case division 
of labor is entirely practicable. If transit facilities in 



126 INTRODUCTION TO ECONOMICS 

the large city are excellent, the number of men that 
may be employed by a single tailoring establishment may 
be one hundred or more, and labor may be as minutely 
subdivided as the employer desires. In the making of 
furniture at the order of the consumer, similar limitations 
upon division of labor are found. The small town is 
able to support only a small shop, where all the work is 
performed by two or three men, while the large city 
renders possible the large shop, with minute subdivision 
of labor. 

7. The degree in which the functions of production 
may he subdivided is dependent upon the pre- 
vailing form of economic organization. < 

Where each workman is his own employer, as was 
generally the case in the mediaeval industrial organiza- 
tion, labor cannot be very minutely subdivided. In such 
an industrial organization the spinner buys his wool and 
sells his product to the weaver; the latter sells the cloth 
to the fuller, who, in turn, sells it to the dyer. The 
product is again sold, perhaps, to the shearer, who in 
turn sells the finished cloth to the draper, who deals 
directly with the consumer. With such a form of organ- 
ization much time is necessarily wasted in the buying 
and selling of the material in its several stages, and the 
greater the number of stages, the greater the waste from 
this source. Again, as each person follows his own taste 
in choosing his trade — ^ subject, of course, to family 
tradition and trade restrictions — it is unlikely that the 
society will have just the right number of craftsmen of 
each kind. At one time there will be too many spinners, 
relatively to the number of weavers; at another time 
fullers will be so numerous that not all can be em- 
ployed. And this element of waste also increases with 
increasing subdivision of labor. 

Where, on the other hand, industry is carried on 



SPECIALIZATION OF ECONOMIC FUNCTIONS 127 

under the factory system, the workmen are assembled 
under one roof, subject to the control of an employer. 
The material passes through the shop without interrup- 
tion, and beginners are taken on in each branch in the 
proportions which experience shows to be most desirable. 
Of course this implies a large accumulation of wealth on 
the part of the employer, who must provide the premises, 
furnish materials, pay wages, and assume all other ex- 
penses of production. In fact, we may say that large 
capital and efficient management are prerequisites to a 
thoroughgoing system of division of labor. And, of 
course, efficient management on the part of the employer 
implies a corresponding readiness to submit to direction 
on the part of the employee. We might easily conceive 
of a society in which all other conditions requisite to 
division of labor might exist, but in which division of 
labor of an advanced type would, nevertheless, be im- 
practicable on account of the restiveness of the working 
population under close direction. 

8. From a business point of view, the principal 
advantages of division of labor are (i) in- 
creased skill and speed in production; 
(2) fuller utilization of time; (3) greater ease 
of supervision. 
To enumerate all the advantages of the division of 
labor would require a volume; but we may group the 
more important ones under a few heads. In the first 
place, the limitation of the labor to be performed by 
one man to a single function, which involves the use of 
a single tool, and which may be reduced to a few simple 
movements, makes possible accurate workmanship and 
great speed, with relatively little weariness. The work- 
man soon reduces his movements to a rhythm; he grasps 
each piece of material in the same way, delivering 
his strokes upon it in such a way as never to throw away 



128 INTRODUCTION TO ECONOMICS 

his energy. Every one knows how much better re- 
sults a trained oarsman secures from the expenditure of 
a given amount of muscular energy than the raw be- 
ginner, who puts forth his strength now on the water, 
now on the air, now in the right direction, now in the 
wrong one. The difference in effectiveness between the 
strokes delivered by the man who works with a single 
tool, and the strokes delivered by one who works with 
a dozen tools, is hardly exaggerated by the comparison. 

Even the best workman loses some time in changing 
from tool to tool. It is not difficult to find a carpenter 
who spends many fruitless moments searching now for 
his saw, now for his hammer, while the whereabouts of 
a plane or square, when those implements are needed, 
proves a baffling, if not insoluble, problem. And this 
is the man who leaves his work with the loudest com- 
plaints of his weariness. A division of labor that holds 
a man so strictly to business that he never has a chance 
to stop to search for anything, contributes materially 
to reduce such waste of time and energy. 

The simplification of the task of each laborer makes it 
a comparatively easy matter to ascertain how much any 
particular one is actually doing. One who has lived in 
the country has probably made the acquaintance of two 
types of laborers: the first, those who are always bustling 
about in a hurry and yet accomplishing little; the second, 
never in a hurry, yet showing, in the end, a good record 
of achievement. Because of the miscellaneous character 
of the work of the agricultural laborer, it takes a long 
time to measure the relative efficiency of different men. 
Where a man is compelled to repeat the same operation 
throughout the day, no show of bustling energy will 
create the illusion of achievement. The pieces of work 
done have simply to be counted to give an accurate idea 
of the laborer's efficiency. It is obvious, then, that the 



I 



SPECIALIZATION OF ECONOMIC FUNCTIONS 129 

difficulty of supervision is greatly reduced by systematic 
division of labor. 

9. From a social point of view, the principal 
advantages of division of labor are: (i) that 
it affords a place of usefulness to many who 
would otherwise he of little use to society; 
(2) that it opens opportunities for special 
abilities; and (3) that it facilitates mechanical 
progress. 
Under frontier conditions, where each man must per- 
form a wide variety of functions, some prove utter 
failures, wasting so much time turning irresolutely from 
task to task that they accomplish nothing. These same 
men might prove highly efficient workmen under differ- 
ent industrial conditions. If our frontier communities 
had kept detailed records, we should find that they con- 
tained many a man who would have made a good archi- 
tect or engineer, many a woman who would have made an 
excellent modiste or teacher, but who proved hopeless 
failures in the environment in which they were placed. 
Architecture and engineering, designing of costumes and 
teaching of children, were indeed functions not wholly 
neglected, but they made up a very small part in the 
life of each family and gave little opportunity to any one 
for the full development of his natural talents. 

Division of labor makes the attainment of a place of 
usefulness possible for persons who have not the time or 
the versatility to learn how to perform a variety of 
functions. There are many persons who cannot afford 
the time to learn the tailor's trade; many who have the 
time for apprenticeship, but not the general ability re- 
quired for the making of a well-fitting coat. Few persons 
are so stupid that they cannot, with slight waste of time, 
learn how to sew a straight seam. If the work of mak- 
ing a coat is distributed among a dozen persons, each 



I30 INTRODUCTION TO ECONOMICS 

one can quickly learn to do well his particular part. 
Further, in the distribution of the work, each one may 
be given a task proportioned to his ability. The skilled 
cutter will not waste his time picking basting threads, 
and the person for whom the latter function is a suffi- 
cient profession, will be kept from spoiHng material 
through attempting something more ambitious. 

Perhaps the greatest advantage that arises from divi- 
sion of labor is the stimulus it gives to the invention of 
labor-saving machinery. A hundred years ago it would 
have seemed quite impossible to make shoes by machin- 
ery. The process of manufacture appeared so compH- 
cated that hand labor alone would answer. To-day shoes 
are largely the product of machines. Many forces cooper- 
ated, of course, to bring about this result, but only one 
of these concerns us here, the division of labor. When a 
complicated operation hke the making of a shoe has 
been split up into several score of simpler operations, 
some of these are Hkely to prove so nearly mechanical 
that the idea of machines to take over the work suggests 
itself. If the process of production is divided into 
twenty-five parts, perhaps the third, and eleventh, and 
seventeenth are taken over by machines. In time divi- 
sion of labor still further simplifies the remaining opera- 
tions; additional ones prove to be fitted for machine 
work, and thus more of the hand-workers are displaced. 
It is conceivable that in the end practically the whole 
process might be taken over by machines, while the 
hand-worker might be transformed into an attendant of 
the machine, so to speak, feeding it with material, and 
passing on the product to another machine. 

10. From a social point of view the division of 
labor is attended by serious drawbacks. 

The division of labor greatly increases the productive 
ef&ciency of the social working force, and this is from 



SPECIALIZATION OF ECONOMIC FUNCTIONS 131 

every point of view an advantage. It makes possible 
the utilization of many forms of labor that would other- 
wise find no place in the productive organization. This 
is an advantage when the form of labor utilized is in- 
capable of development, as in the case of adults below 
the average in strength or in intelligence. Persons who 
would have to starve or beg under a system of com- 
pUcated employments are often able to earn a fair Hving 
under a system of simpHfied employments. 

On the other hand, the division of labor, and the 
accompanying development of machinery, give induce- 
ment to the employment of classes that should not be 
employed at steady and monotonous labor. Children 
and persons faihng in health are drawn into the circle of 
sustained labor. The former should be allowed to de- 
velop their faculties in a natural way; the latter, to re- 
cover their health. When each employment required all 
the faculties of a normal man, there was nothing to tempt 
producers to employ laborers of this class. Since the 
introduction of division of labor, the evil of employing 
those who should not be employed has assumed serious 
proportions. Legislation has been invoked to hmit the 
employment of children, but in few countries has child 
labor been subjected to wholly satisfactory regulation. 

Another serious disadvantage of the division of labor 
is that it tends to reduce the pleasure men derive from 
their work. The artisan who produces a completed piece 
of work usually takes an active interest in it. The 
carpenter takes pride in the houses he has built; the 
cabinetmaker, in the furniture that has come from his 
shop. It is a common thing to find men belonging to 
these trades — representatives of the earher order — re- 
luctantly leaving their work when the whistle blows or 
the foreman shouts ''Time up." Not so with the work- 
man whose day is spent in performing some minute part 



132 INTRODUCTION TO ECONOMICS 

of the work of producing each one of a multitude of like 
commodities. His part in production is merged with that 
of his numerous fellows. He may, if he is of sanguine 
temperament, take pride in the achievements of the estab- 
lishment where he is employed; but for the most part 
his interest in the work is dependent on his prospect of 
receiving increased pay. 

A further disadvantage of division of labor is that it 
renders the workman dependent on a certain kind of 
work, and therefore exposes him to the risk of unemploy- 
ment when supplies of material are wanting or when 
markets fail. There are in most modern countries many 
men and women who are well-trained textile workers, 
but who do not know how to find other employment 
when a crisis causes a contraction of the textile industry. 
The higher the degree of specialization, the more serious 
are the effects of changes in industrial conditions. 

11. Progress in the specialization of economic 
functions is subject to a law of diminishing 
returns. 

We may now consider how far the principle of division 
of labor modifies the operation of the principle of dimin- 
ishing returns, described in the last chapter. According 
to the latter principle, an increase in the amount of 
labor employed in connection with a limited amount of 
capital gives a return which is not proportionate with 
the increase in labor. But what if the additional laborers 
give opportunity for division of labor which had not 
before existed? Suppose that a tailor's shop with a 
capital of $20,000 formerly employed six men; it now 
employs twelve men. Division of labor can be carried 
farther with twelve men; hence is it not possible that 
the employment of the second six men will double the 
output of the shop? This is quite possible. An addi- 
tional six men will give occasion to still more systematic 



SPECIALIZATION OF ECONOMIC FUNCTIONS 133 

division of labor, and so may still further increase the 
efficiency of each man. And so with a fourth set of six 
men. But it is evident that one cannot go on indefinitely 
subdividing the work of making a coat. Eventually a 
point wiR be reached where further subdivision of labor 
increases the efficiency of each laborer only sKghtly; 
still further subdivision, even less; ffiially a degree of 
subdivision will be found that will not pay. That is, 
the principle of division of labor is itself subject to dimin- 
ishing returns. A practical illustration of this fact is 
to be found in the organization of the working force in 
many large estabHshments where much use is made of 
division of labor. The making of a complete article is 
not assigned to a single man; nor is it assigned to all 
the men in the shop. Each article is assigned to a 
"team," among the members of which the successive 
manipulations of the material are distributed. The en- 
tire working force may contain scores of teams. Now, 
the size of each team indicates the limits of the profitable 
division of labor. If an enterpriser limits each team to 
sixty men, this is proof that in his opinion a team of 
seventy men would not show so large a product per man. 
We may grant that an increase in laborers employed 
in connection with a given capital may possibly result in 
an increase in product more than proportionate to the 
increase in labor. This may hold true until the number 
of laborers is sufficient to compose a team of maximum 
efficiency. If an additional team is engaged, without 
increase in capital, it is doubtful if returns will increase 
in proportion to the number of teams; a third team will 
show a return less than that of the second, and so on 
until the point is reached where it does not pay to em- 
ploy an additional team. So far as the principle of 
division of labor is concerned, then, the only qualifica- 
tion to be made in the law of diminishing returns is 



134 INTRODUCTION TO ECONOMICS 

that when we assume that labor increases, we must 
assume that it increases by teams, not by individual men. 

12. Summary. 

In the course of economic evolution, one after another 
of the functions of the primitive family group has been 
taken over by persons who make a specialty of it. 
The development of exchange has been a condition and 
a cause of the tendency toward specialization. The 
differentiation of economic functions may rest with the 
assignment to each individual of a particular trade, or it 
may be carried so far as to subdivide the work of a single 
trade. In the former case we have what is known as 
differentiation of occupations; in the latter, division of 
labor. 

A high degree of division of labor presupposes a well- 
developed commercial organization. Improvements in 
transportation increase the number of fields in which the 
principle may operate, as does also increase in the density 
of population. In a society in which production is 
carried on by employer-capitahsts with hired workers 
division of labor can be carried much farther than in 
a society in which the laborer works on his own account. 

The productive power of society has been greatly in- 
creased by differentiation of functions. The subdivision 
of tasks makes it possible for each individual however 
limited his abihties, to find some task that he can execute 
successfully. Above all, it faciUtates mechanical prog- 
ress. On the other hand, it encourages employers to 
substitute child labor for the labor of men, and it de- 
stroys, in large measure, the pleasure that men find in 
their work. 

Up to a certain point progress in the division of labor 
neutralizes the effect of diminishing returns. But division 
of labor is itself subject to diminishing returns; the 
earlier stages in the process are more fruitful than the 
later ones. 



CHAPTER VIII 
MANAGEMENT 

1. Management, under primitive conditions is a 
function usually attached to the ownership of 
capital. 
In the small industrial establishment t3^ical of early- 
nineteenth century America, the whole oversight of the 
productive and commercial operations devolved upon the 
proprietor. It was he who determined whether the mar- 
gin between the prospective price of the product and 
the present cost of material, labor and power warranted 
production at all or required the temporary closing 
down of his establishment. The proprietor provided 
himself with such machinery as he thought he required 
and could afford, hired efficient labor at high wages 
or less satisfactory labor at lower wages and kept 
up such discipHne as seemed to him effective. His self- 
interest sharpened his eye, and made him keen to avoid 
mistakes. But naturally he was not all-seeing. Usually 
there were many leaks that escaped his attention. Some 
proprietors were more competent in managing than 
others, and were more likely to survive in competition. 
There was accordingly a gradual progress of the bulk of 
industry toward better management, but it was painfully 
slow. We need no better proof of the general blindness 
of early nineteenth century managers than the fact that 
practically all of them worked their employees twelve, 
thirteen or fourteen hours a day, although it was being 
demonstrated by Robert Owen and other capable em- 

135 



136 INTRODUCTION TO ECONOMICS 

ployers that in the long run more can be got out of a 
workman in a day of moderate length than out of an 
excessively long day. 

It is not necessary, however, to go back to early in- 
dustrial conditions to find examples of management 
attached incidentally to ownership. Almost the whole 
of American agricultural enterprise is still carried on 
under that system. So also are the innumerable small 
shops in village and city, much of the repair business, 
a large part of the clothing industry, and many other 
manufacturing enterprises of considerable importance. 
In all this vast field common sense, instinct and rule of 
thumb are characteristic of management. And every- 
where there are leaks, which often become serious enough 
to end in business failures. Where the leaks are less 
grave they cut down, more or less severely, the returns 
on the proprietor's capital and efforts. This is especially 
the case in farming. When the farmer owns his land, 
free of encumbrance, and with the aid of members of 
his family does practically all the work on it, mismanage- 
ment can make him work unnecessarily hard for un- 
reasonably small returns, but it can not ruin him. We 
find farmers who go to the trouble of maintaining dairies 
when the price of dairy products does not cover the cost 
of the forage and grain, reckoned at the prices prevailing 
in the local markets. One farmer will maintain horses 
enough to eat up the chief part of the products of his 
labor, while another will have too Kttle horsepower to 
keep his fields properly tilled. One will have much more 
machinery than he can use to advantage, while another 
wiU waste his labor performing by hand operations that 
could be done more cheaply by machines. But still they 
survive. 

The wastefulness of bad management brings its penal- 
ties in more striking form in commercial and industrial 



MANAGEMENT 137 

establishments. The street vendor who loses on bananas 
all he makes on peanuts is destined to be crowded out of 
business unless he drops the luxury of handling bananas. 
The owner of a ''general store" who persists in loading 
up his shelves with goods that will not sell will sooner or 
later go into bankruptcy. The penalties of bad manage- 
ment are so drastic that it is easy for the student of eco- 
nomics to fall into the assumption that bad management 
can nowhere persist for any length of time. But it must 
be borne in mind that competition is not to be compared 
to a race between perfect athletes trained down to the 
last ounce of superfluous weight, but more properly to a 
free-for-all scramble among the handicapped, some lame, 
some broken-winded, some suffering from bad hearts, 
some inattentive and lazy. The less bad win, but the 
winners may still be very bad indeed, judged by any 
reasonable standard of perfection. 

2. In the more highly developed industry, manage- 
ment becomes a function differentiated from 
ownership. 

When a business attains to any considerable size, it is 
of course impracticable for the owner to keep a personal 
oversight of all the detailed operations. Instead of deal- 
ing directly with the individual workman, the owner 
acts through foremen, who are supposed to know the 
character of the work to be performed and to be capable 
of judging whether the workmen are putting forth their 
best efforts. The owner may remove himself a stage 
farther from the productive process by setting up a super- 
intendent between himself and the foremen. He may 
further subdivide the management, placing one man in 
charge of the selHng force, another in charge of buying 
materials and machinery, while a third manages the busi- 
ness of production. As a rule, the larger the business, the 
greater the subdivision of management and the greater 



138 INTRODUCTION TO ECONOMICS 

the number of links between the owner and the men 
who actually manipulate the material. 

Great variety naturally appears in the degree of re- 
sponsibility reposed in the various managing officials. 
In some cases these can only submit recommendations. 
The owner reserves final decision to hiiAself. But com- 
monly all routine functions are settled definitively by 
the managers, and only the general strategy of the es- 
tablishment is reserved to the owner. If times are bad 
and it appears that production may involve loss, the 
owner determines whether operations shall be restricted, 
and in what branches. If times are good, the owner 
determines whether new equipment or an extension of 
plant would be desirable. And of course he watches re- 
ceipts and expenditures and forms his ideas as to whether 
the management is efficient or not. When he concludes 
that matters are not going so well as they might, he 
tries to determine where the source of the difficulty lies 
and replaces one official or another whom he judges in- 
competent. The superintendent or manager in charge of 
a group of foremen is likewise watching the results of 
each one's work, and if discretion Hes with him, dismisses 
those who do not seem competent. And the foremen in 
turn keep watch of the workmen. Where the foreman 
has discretion, as he often has, he is expected to keep his 
eye open for slackers and trouble-makers, and replace 
them with a more useful personnel. 

In this stage of development management is mainly a 
selective and discipHnary process. From the top down, 
men are chosen for their jobs with a view to their com- 
petence, and are held to successful performance by the 
penalty of dismissal. There may, of course, be additional 
disciplinary methods in use; extra pay for good work- 
manship, a system of fines for tardiness, irregularity, in- 
jury to machinery or waste of materials. But through- 



MANAGEMENT 139 

out, the process depends on the keenness of eye, the com- 
mon sense and good judgment of the men holding dis- 
cretionary power. Men are taken on and dismissed 
without anything Hke a systematic determination of their 
fitness or unfitness. There is no certain relation between 
the extra rewards for excellent work and the value of that 
work to the enterprise. Still less are fines nicely grad- 
uated to the delinquencies for which they are imposed. 
There is necessarily much room here for whim and per- 
sonal Hkes and dishkes. Some check is placed upon the 
action of the foreman when the workers are strongly 
organized. Organization also places Hmits upon the dis- 
cretion of the management in fixing the scale of wages 
and in establishing extra rewards and penalties. But 
organization does not affect the conditions of the higher 
grades in the management nor does it divest the system 
as a whole of its rule of thumb character. 

3. Under the scheme of management generally 
prevailing, American industry falls far short 
of any reasonable standard of efficiency. 

It is natural that Americans should regard with com- 
placency the achievements of American business enter- 
prise. As compared with earlier epochs, American busi- 
ness enterprise to-day has attained remarkable results. 
In spite of the fact that wages have risen and conditions 
of employment have been much improved, a great variety 
of products can be brought to market at lower costs than 
was possible half a century ago. As compared with busi- 
ness enterprise in other modern states, that of America 
can claim a certain preeminence. Nowhere else is the 
product per man so large as in America, nor the wages of 
labor so high. There can be no doubt that relatively to 
that of most other countries, American business manage- 
ment is highly progressive. American business men may 
cling .too long to methods that are wasteful, but they do 



I40 INTRODUCTION TO ECONOMICS 

not match their foreign competitors in the conservatism 
that permits antiquated methods to survive. 

But such comparisons should not bHnd us to the fact 
that the prevailing scheme of management does not by 
any means achieve the best results practically attainable. 
In a survey of six typicaL American industries conducted 
in 1920-21 by a committee of the Federated Engineering 
Societies, it was found that the average estabHshment 
fell 28.66 per cent short of a practicable maximum in the 
metal trades, the most satisfactory industry studied, and 
63.78 per cent short in the men's clothing industry, the 
least satisfactory. In all the six industries, taken as a 
group, the average estabHshment did not attain to fifty 
per cent of its practicable maximum of efficiency. And 
that maximum, it must be observed, represents no theo- 
retical best, but merely what could be attained if the best 
methods and practices actually in use somewhere in the 
industry were brought together and appHed in a single 
plant. 

It is not at all an unreasonable estimate that without 
any increase in labor or in the capital invested in ma- 
chinery, the output of American industry could be in- 
creased twenty-five per cent or more by improved man- 
agement. Every laborer and capitaHst and enterpriser 
could enjoy a twenty-five per cent increase in the goods 
i placed at his disposal. And this result would not pre- 
suppose any new inventions, or the devising of any new 
methods of management. It would presuppose only the 
general application of methods and technique already 
being successfully applied somewhere. 

4. An essential part of good management is the 
application of a rational system for determin- . 
ing costs. 

If you ask a farmer how much it costs him to produce 
a quart of milk, a dozen eggs, a pound of pork, the chances 



MANAGEMENT 14I 

are a hundred to one that he can not tell you, or if he 
does give a definite figure, it will be a wild guess. He 
may be able to tell you how much the aggregate annual 
product of his farm has cost him — although it is not 
likely that he can — but he has no rational scheme for 
distributing this cost among the several products which 
he sells or uses at home. And yet it is of importance to 
determine this distribution. If the farmer knew that he 
was losing money on milk and making money on hogs 
and poultry, he would cut down his dairy herd and de- 
vote himself to the more fruitful part of his production. 
But since his farm provides his housing and the better 
part of his food supply, he may afford the luxury of 
carrying on branches of husbandry that do not pay. 

What is far more surprising is that a great many manu- 
facturing and commercial enterprises have no system of 
cost accounting to guide them away from unprofitable 
undertakings. For example, in a small town, a dealer in 
lumber, coal and feed may keep no books that indicate 
precisely how much each part of his business costs. For 
all the proprietor knows, he may be losing money on 
feed and making up his loss on lumber. He might be 
better off if he dropped feed from his list. A hardware 
manufacturer often does not know what his saws, chisels, 
hammers and axes cost him. Very Hkely one or another 
of these items costs more than the price at which he 
sells it. 

What complicates the problem of cost accounting is 
the uncertainty that clouds the proper distribution of 
various items in cost. Let us suppose that a hardware 
manufacturer is considering whether he can afford to 
make an ax which he can sell to a jobber for one dollar. 
It is easy to determine the cost of the material that goes 
into the ax. We will put that item at twenty-five cents. 
The labor directly employed in making the ax costs, we 



142 INTRODUCTION TO ECONOMICS 

will say, another twenty-five cents. Allow ten cents for 
fuel and wear and tear on the machines and tools used; 
there still appears to be a surplus of forty cents. But 
have we allowed for all the items in cost? No. The 
manufacturing business as a whole has to pay interest on 
capital invested in ground, buildings and machinery. It 
has to pay wages to managers and superintendents; it 
has to pay taxes, costs of advertising, etc. All these 
charges ' that do not distribute themselves directly — 
known as overhead charges, or simply as ''overhead" — ■ 
ought to be borne in some fair proportion by all the items 
sold. For the ax the overhead may exceed the forty 
cents of apparent surplus. Then it does not pay to pro- 
duce the ax, unless of course nothing that will pay can be 
produced by the machinery which produced the ax. But 
if such is the case, it was a mistake to buy the machinery 
at all. Good management will equip a plant only with 
machinery designed to turn out products that pay their 
own direct costs together with their due proportion of 
overhead. 

5. Good management applies expert attention to 
the problem of saving material. 

Turn five equal bolts of cloth over to five fairly skilled 
tailors with instructions to cut the cloth up into sleeve 
pieces of a given pattern. Will the number of sleeve 
pieces be the same for all of them? Far from it. The 
variation in number may be ten per cent or more. And 
probably even the best one will leave ten per cent more of 
the cloth in the form of worthless scraps than is really 
necessary. The housewife who makes clothes at home 
may afford to waste cloth by haphazard cutting. Not so 
the clothing manufacturer. All his profit will be carted 
out in the scraps, unless he takes heed. And indeed this 
happens at times. The best managed clothing plants 
have definite systems of measurement that insure the 



MANAGEMENT 143 

fullest possible utilization of the material. But there are 
others which leave the matter to the judgment of the in- 
dividual cutters with consequent serious loss of materials. 
The same conditions appear in the shoe making industry. 
The report of the Committee of the Federated Engineer- 
ing Societies on Waste in Industry states that in cutting 
leather for uppers, it is not unusual for one cutter to use 
up a hundred dollars' worth of leather a week in excess 
of what another cutter uses up in producing an equal 
number of pieces of the same grades of stock. 

Analogous differences in the use of fuel affect every 
industry. One manager, by close attention to furnace 
equipment and methods of firing, will get ten, fifteen or 
twenty per cent more power out of each ton of fuel than 
another. What is essential to good management here is 
close antecedent study with time and money spent, if 
necessary, on careful experimentation, and systematic 
training of the men who are to apply the methods which 
have been found most economical. 

6. Good management involves careful planning of 
the production process so that it may move 
forward smoothly without clogging at any 
point. 

Most products placed upon the market are the outcome 
of a large number of operations which must be executed, 
as a rule, in series. In the clothing industry, for example, 
from 80 to 150 operations are required to make a sack 
coat. Unless the whole system of operations is nicely 
planned, the material will clog at one stage or another, 
leaving part of the working force and the machines idle. 
In the best managed shops the planning is done well 
enough so that all the workers and machines are kept 
uniformly busy, but in the majority of shops that is by 
no means the case. 

The building industry, since it is carried on under the 



144 INTRODUCTION TO ECONOMICS 

eyes of the general public, offers the most familiar in- 
stances of the losses due to imperfect planning. Say that 
you are having a house built, and visit it day by day, 
eager to have it finished so that you may move in. You 
visit it one morning: a half dozen hammers are tapping 
merrily. Suddenly the sounds cease; you make your 
way to the living room where the floor was being laid and 
find the carpenters packing their kits. There is no more 
flooring on hand, they explain; perhaps additional floor- 
ing will be delivered the next day or the next week. Or 
one day you find a troop of new men in spotted overalls 
sitting on nail kegs and gossipping with the plasterers. 
The painters; they have come too soon, and will have to 
go off to another job, to reappear in a week or two, after 
the operation has stood dead for several days waiting for 
them. Of course you may say that in such a case it is 
not the building contractor — the enterpriser — ■ who loses 
money because he failed to plan his work well. It is you, 
the consumer of services, who pays. Very well. But 
consumers become discouraged when vexations and exac- 
tions are too numerous. The volume of building is kept 
down and the business of the building contractor lan- 
guishes. 

7. Good management does not leave the choice of 
tools and methods of using them to the chance 
preference of the worker, hut is at pains to 
secure satisfactory adaptation. 
If you were required to cut a half cord of wood daily, 
do you know just what kind of ax would enable you to 
do it in the least time? Say that you have a dozen to 
choose from, with a dozen differences in weight, in width 
of edge, in length of helve. If you have never used an 
ax regularly, you will have only the vaguest notion as to 
which one would best suit your requirement. But you 
must select one. You try one with a fairly heavy head 



MANAGEMENT 145 

and long helve. After some days you try another. In 
the meantime you have adjusted your muscles to the 
first, and that prejudices you against every other. And 
so, unless you made a very bad mistake in your first 
choice, you will return to it; and the longer you work 
with it, the more you will be inclined to favor it. If you 
break it, you will select another very much Uke it. Yet 
it may be that if at first you had selected another ax, 
your average efficiency would be ten per cent greater. 

The principle involved in this example is that in mat- 
ters of manual technique, wrong choices tend to perpet- 
uate themselves through habit. When I write these lines, 
do I keep my paper and pen in just the relation that 
makes writing easiest, the physical obstruction to the 
flow of my ideas least? It is a hundred to one that I do 
not. I am working in a deep worn channel of habit, a 
channel first traced out, I suppose, by a teacher who 
wanted me to hold my hand in writing just as some ex- 
tinct authority, with a different constitution of bone and 
muscle and nerves, was supposed to have held his hand. 
When you read these lines, do you hold the book in just 
the best relation to your eyes and the light so that the 
physical friction to the flow of your ideas is at* a mini- 
mum? A hundred to one, you do not. It does not make 
a great difference to us. We do not read or write enough 
to make us old before our time. But the man who has 
the wrong habit of using his ax or shovel or wheel- 
barrow — usually the wrong type of implement besides — • 
does grow old before his time and achieves too Httle. 

The writers on the art of management — scientific 
management most of them prefer to call it — have filled 
volumes with the striking results that can be attained, 
and have been attained, through the application of ra- 
tional management to the equipment and manual habits 
of workers. They have shown how the average brick- 



146 INTRODUCTION TO ECONOMICS 

layer can double or treble his performance by a better 
adjustment of scaffolding which allows him to ehminate 
excessive stooping, by closer attention to the consistency 
of his mortar, by learning how to pick up a brick and how 
to lay it down. One might suppose that this last part of 
the art of bricklaying would have attained to perfection 
within the trade in the time that has been given to it 
since the construction of the Tower of Babel. But no, 
the scientific managers have demonstrated that brick- 
layers do not know how to pick up bricks. It remains for 
good management to teach them the art. 

Neither do professional shovellers know how to shovel 
coal. Polakov's ''Mastering Power Production" cites an 
instance in point. Four men each working twelve hours 
a day, were required to move by shovel and wheelbarrow, 
180,000 pounds of coal a day. They could not stand the 
work long, and gave it up. A little intelligent thinking 
was then applied to their equipment. They were found 
to be working with short handled shovels of sixteen 
pounds capacity and wheelbarrows of 250 pounds, built 
so as to throw an excessive weight on the arms. In place 
of this equipment, they were given long handled shovels 
of 21.5 pounds capacity and wheelbarrows of 400 pounds 
capacity, but lighter on the arms. In consequence of the 
change, the men found themselves able to move 65,000 
pounds each in eight hours instead of 45,000 in twelve. 
Moreover there was no longer complaint that the work 
was too hard. 

It would be going too far to say that all manual equip- 
ment and all manual habits are wrong. But it is not 
going at all too far to say that wrong equipment and 
habits are so general and so much of a handicap to effi- 
ciency, that a golden harvest awaits the managers who 
can make substantial progress toward substituting the 
right equipment and the right habits. 



MANAGEMENT 147 

8. A prerequisite to good management is securing 
the good will and cooperation of the workmen 
employed. 

Many improvements in management can of course be 
made without directly involving the relations of em- 
ployer and employee. Whatever these relations, good 
planning, proper choice of equipment, systematic account- 
ing, will stop many leaks and often substitute profits for 
losses. But the greatest leak of all is the active discon- 
tent of labor, with its consequences, lack of diligence and 
attention, and frequent changes in the working force. 
The management may do its very worst in the way of 
imposing fines and holding the threat of dismissal over 
those who do not come up to the standards; but the 
best work is simply not to be got out of an unwilling 
workman. It was not to be got out of slave labor, with 
all the atrocities of that system. Still less is it to be got 
out of free labor. 

It has been pointed out that in the early period of 
American industry the working day was much longer 
than even the interest of the employer, if it had been 
enlightened, would have fixed. Employers, like manual 
workers, form bad habits. They adjust their operations 
to the premise that they may command a certain number 
of hours of the workers' time, and they stick resolutely 
to the view that they benefit by holding firmly to every 
hour. Yet there is abundant evidence that in a wide range 
of industry, a worker will in the long run accomplish 
more in an eight hour day than in one of ten or twelve 
hours. During the Great War, the British Ministry of 
Munitions assumed for a time that in the national emer- 
gency it was justifiable to remove all restrictions on over- 
time and hold the munitions workers to ten, twelve and 
occasionally fourteen hours. The immediate result was 
a speeding up of production. But presently chronic 



148 INTRODUCTION TO ECONOMICS 

fatigue supervened, and the working day had to be cut 
back toward the eight hour limit, simply in the interest 
of maximum production. 

There is, of course, no specific number of hours that 
represents the most effective working day for all classes 
of labor. In general, employments that involve a heavy 
drain upon the attention require a shorter day than those 
in which operations are so mechanical that one can 
attend them satisfactorily while his wits go wool-gather- 
ing. But it is probably true that as a rule, the working 
day is too long. It is to be borne in mind that all our 
industry grew up with the habit of the long day taken 
over from the more primitive, less nerve racking condi- 
tions of agricultural Hfe, and that employers as a class 
have steadily opposed every change to a shorter day. 
Undoubtedly there are still innumerable vestiges of the 
the destructively long day, which it is the business of 
good management to excise. 

Still more vital than the question of hours is the 
question of wages. It is vain to expect maximum per- 
formance from workers who are housed in hovels, clad in 
rags, fed on innutritions fare. They could not do good 
work, even if they had the will, and the will is not in 
them. An adequate standard of living is just as much in 
the employers' interest as efficient equipment. A copi- 
ous encyclopedia would be required to record the in- 
stances in which an increase in wages was accompanied 
by a more than proportionate increase in efficiency. We 
are constantly hearing of the menace to American in- 
dustry of the cheap labor of Europe and the Orient. 
But the fact is that except in industries specially circum- 
stanced, high priced American labor is cheaper than the 
low priced labor of foreign countries. China, for example, 
has excellent deposits of iron ore, and vast beds of the 
best coal. But Chinese steel rails do not threaten to drive 



MANAGEMENT 149 

American rails off the international market. The Japa- 
nese, with their favorable commercial position, have made 
great inroads into the market for cheap cottons in China. 
In better grade cottons, Japan does not compete success- 
fully in the international market with higher priced occi- 
dental labor. When oriental labor becomes dear enough 
to afford a good standard of living, we shall perhaps have 
reason to fear its competition. 

In the matter of wages, as in that of hours, the indus- 
try of today is still afHicted in some measure by bad 
habits taken over from the original rural environment. 
Industry found labor cheap and adjusted itself to that 
cheapness. It has resisted every rise in wages, crying 
ruin whenever the movement for higher wages became 
formidable. Wages have risen and the ruin has not 
supervened. On the contrary, prosperity has ultimately 
been advanced by rising wages. It may be and indeed it 
is very probable, that in many occupations a further in- 
crease in wages could be granted with more than propor- 
tionate increase in efficiency. Good management will 
detect such points, and both increase efficiency and im- 
prove the attitude of labor. 

When labor is discontented, it shifts constantly from 
one employer to another, except in the occasional crises 
of unemployment when men cling desperately to their 
jobs. This shifting of personnel, it has come recently to 
be understood, is an extremely wasteful process. Every 
new man taken on by an establishment has to be broken 
in, even if he is familiar with the general processes em- 
ployed. While this breaking in is going on, his value to 
his employer is often less than his wages. Some in- 
dustrial managers have placed the cost of adjusting a 
new man to his place at hundreds of dollars. It is, then, 
a great handicap to an establishment to have men con- 
tinually leaving to try their luck elsewhere. Yet many 



I50 INTRODUCTION TO ECONOMICS 

managers have tolerated a shifting so rapid as to re- 
place their entire working force on the average twice a 
year, or even more frequently. Such a replacement is 
known as a ''labor turnover. " The frequency of the "labor 
turnover" is one of the tests of the quality of manage- 
ment. A good manager will devise means for holding his 
labor beyond the term customary with the industry. And 
that involves a systematic study of the attitudes, habits 
and aspirations of labor that few managers have as yet 
undertaken. It involves a readjustment of wages sys- 
tems, as well as a sympathetic attitude toward the or- 
ganizations on which laborers are more and more relying 
for the defence of their interests. 

It is not to be supposed that laborers will take kindly 
to the remoulding of their manual habits unless they are 
to share the benefits of the increased production. The 
scientific managers have worked out a great many 
schemes of bonus payment for exceptional performance, 
designed to secure the cooperation and good will of 
labor. Some of these schemes have worked well, for a 
time, and then have failed. It may well be doubted that 
it will ever be possible to institute a mechanical scheme 
of wages payment that will insure permanent harmony 
and good will. What is needed is a continuous personal 
relationship between management and labor which will 
establish in the minds of the laborers a confidence in the 
management and a belief that the interests of labor are 
given full consideration, along with the interests of the 
capital of the enterprise. 

9. A consequence of the general improvement in 
management is to provide more goods and 
hence to increase the social welfare. 

In working to improve his art of management the 
enterpriser is aiming at increasing his profit. He does 
not lower prices to the consumer simply because he is 



MANAGEMENT 151 

able to produce at lower costs. But if he has found a 
system which insures him a comfortable margin of profit, 
he naturally increases his output, and in so doing tends 
to bring prices lower. As other enterprisers in the same 
industry copy his methods or work out equally effective 
methods of their own, prices tend more strongly to fall. 

But improvements in the art of management, hke im- 
provements in the methods of utilizing fuel, are not 
restricted by nature to any one industry, but, with appro- 
priate modifications, may be applied generally. Accord- 
ingly, any cheapening will affect not one product alone, 
but most of the other products for which it is exchanged. 
With the increased product of their industry, the em- 
ployers and employees engaged in manufacturing clothing 
are able to buy a larger volume than before of the prod- 
ucts of other industries affected by improved manage- 
ment. Progress toward better management is, then, an 
important interest of society as a whole. It works 
toward placing at the disposal of everyone a more ade- 
quate supply of the necessaries and comforts of life. 

10. In some cases improvements in management 
can he instituted only through collective 
action, often taking the form of standardi- 
zation. 

Just as within each industry there are usually a num- 
ber of operations that must be executed serially, and that 
necessitate careful planning, so among the several in- 
dustries there are serial relations that demand collective 
planning. Thus the lumber industry, transportation and 
the building industry form a series demanding coordina- 
tion. No matter how well the building industry is 
planned, stoppages will be inevitable unless the railways 
bring forward steadily the products of smoothly function- 
ing lumber mills. The printing trades, transportation, 
the paper mills and pulp mills form a similar series. 



152 INTRODUCTION TO ECONOMICS 

Almost every industry takes its place in some such 
series. 

Since each industry is conducted by numerous inde- 
pendent concerns, there is likely to be much that is hap- 
hazard in the interrelations of the industries. Every 
paper mill, for example, tries to make a product that is 
in some degree distinctive, so that a printing estabhsh- 
ment which has once become its customer will be bound 
to it. Consequently there has grown up a vast variety 
of papers differing in weight, sizing, color, and dimensions 
of sheets. The great purchasers of paper, newspaper, 
magazine and book pubHshers, form their own distinctive 
ideas as to the dimensions of sheets, the weight and 
finish of paper. We have in the United States some six 
thousand brands of paper, about half of which are not 
much used. It is of course plain that the differences be- 
tween these grades must often be so minute that only an 
expert could detect them. Fifty or sixty grades would 
probably satisfy whatever natural demand for variety 
exists. 

The consequence of this multiplicity of brands is that 
every important paper dealer has to keep on hand an 
immense stock of paper. The customers destined to call 
on him for immediate shipment in the next month may 
want only grades i, 40, and 300, but he can not be sure 
that they will not demand any one of the numbers 
between the first and the last and additional numbers be- 
sides. He must, therefore, have stock of all grades on 
hand. And that means a great deal of capital tied up, 
accumulating interest charges to be passed on to the 
printer and finally to the buyer of printed matter. 

Nor is this tying up of capital the whole of the diffi- 
culty. No paper dealer can keep on hand enough of 
all these grades to meet any possible demand for one. 
Hence it must often happen that printing is held up, 



MANAGEMENT 153 

workers thrown out of employment, and the profits of 
the enterprise jeopardized because the right kind of 
paper is not to be had, until some factory has had time 
to make it. And at other times, a paper mill has to 
close down because the market, though hungry for other 
brands, does not want the kind this mill is prepared to 
make. 

Similarly in the lumber industry, a great complexity of 
grades has developed where simpHcity would be of great 
value to both the builders and lumber manufacturers. 
Say that a contractor has undertaken to lay hardwood 
flooring in a large hall. The specifications call for a 
given grade and thickness. In the progress of the work, 
the contractor finds that the grade he was relying on is 
exhausted in the local lumber yards, but another grade 
similar in every respect except that it is sKghtly thicker 
is available. What shall he do about it? He will either 
wait for another shipment or lay the thicker lumber and 
dress down the extra thickness by hand. In either case 
there is serious waste, to increase the cost to the owner 
or diminish the contractor's profit. 

Such meaningless handicaps upon industry are a proper 
object of public inquiry or semi-public intervention. Dur- 
ing the Great War, when productive power was at a pre- 
mium, many manufacturers proceeded on the recommend- 
ation of officers of the government, to reduce excessive 
variations in products through the application of rational 
standards. After the war, this movement was taken up 
by the Federated Engineering Societies, whose report on 
Waste in Industry has already been cited in this chapter. 
The progress that it is possible to make through associ- 
ated action under a public spirited impulse is indicated by 
an agreement that was reached among the makers of 
vitrified paving brick. There had been over sixty grades 
on the market, to confuse the public purchasing agents 



154 INTRODUCTION TO ECONOMICS 

and cause frequent stoppages of work for lack of material. 
It was agreed to reduce the number of brands to twelve 
or less. This means less individual character in paving 
bricks, but no doubt more good paving. 

11. Summary. 

Management, originally an undifferentiated incident of 
ownership, has developed into a specialized function, 
with an organization which tends to grow steadily more 
complex. The owner becomes separated by a chain of 
increasing length from the workmen directly engaged in 
production. The traditional form of management, which 
still prevails in American industry, is built upon the 
principles of selection and discipline. The present state 
of management in America, though more efhcient than 
that of an earlier epoch, is far from satisfactory, as 
measured by the best practicable standards. 

A properly developed management is premised upon 
cost accounting. It devotes systematic attention to the 
saving of material; to the planning of production in 
order to insure continuous functioning; to the proper 
adaptation of implements and habits of work. Good man- 
agement secures the good will and cooperation of labor, 
partly through a rational limiting of hours of labor and 
provision of as adequate wages as possible, partly through 
a systematic effort to understand the point of view of 
the laborers and to safeguard their legitimate interests. 
Improvement in management is a public concern of 
great importance, and justifies public intervention where 
the difficulties to be overcome are external to the single 
establishment and involve a whole industry or group of 
industries. In recent years, such intervention has taken 
the form of applying pressure to induce industries to 
apply standardization to their products. 



CHAPTER IX 
THE CONCENTRATION OF INDUSTRY 

1. The average size of the business establishment 
is steadily increasing. 

It is a matter of common observation that to launch 
a business to-day a larger capital is required than was 
the case a generation ago. An examination of the census 
statistics of manufactures shows us how strongly marked 
this tendency toward larger establishments has become. 
From 1880 to 19 14 the number of establishments making 
agricultural implements decreased from 1943 to 601, 
while the aggregate capital of the industry increased 
from $62,000,000 to $338,000,000. The following table 
illustrates the same tendency in other industries : — ■ 



Boots and Shoes 
Chemicals . . 
Furniture . . 
Lumber . . . 



1880 

Number of' 
Establishments' 



4,959 
595 

5>227 

25,758 



1880 

Capital 



$42,000,000 
28,000,000 
44,000,000 

181,000,000 



1914 

Number of 
Establishments 



1,355 

395 

3,192 

27,229 



1914 
Capital 



254,000,000 
224,000,000 
267,000,000 
916,000,000 



k 



In many other industries, while the number of estab- 
Hshments increased during this period, the capital in- 
creased far more rapidly. The number of establishments 
making cotton goods increased from 1005 to 1328, but 
the capital increased from $219,000,000 to $899,000,000. 
Silk manufacturing establishments increased from 382 to 
902; their aggregate capital increased from $19,000,000 

155 



156 INTRODUCTION TO ECONOMICS 

to $210,000,000. There is hardly a single branch of 
manufacture in which the average establishment has not 
increased in size very markedly. The same thing is true 
even in greater degree in the business of transportation, 
both by rail and by water. It may seem that the suc- 
cessful competition of motor trucks and buses with steam 
and electric railways offers an exception to this rule. 
But as motor transport develops, ''fleets" of motors press 
hard upon the owner of the single vehicle. In retail and 
wholesale trade, in banking, and in insurance, we find the 
same general tendency toward an enlarging business unit. 
The present may therefore justly be characterized as an 
era of business concentration. 

In order to understand this tendency, we must acquaint 
ourselves (i) with the external conditions making large 
scale business possible, and (2) with the advantages that 
enable the large business enterprise to prevail in competi- 
tion with the smaller one. 

2. The size of the business establishment is 
limited by the facilities for assembling raw 
material. 

Among the industries showing least tendency toward 
increase in the size of the individual establishment is that 
of canning and preserving fruits and vegetables. In 1880 
the average capital of an establishment engaged in this 
x^industry was $20,000; in 1914 it was $40,000. A cannery 
must depend for its material upon the products of a rela- 
tively small area, since fresh fruits and vegetables cannot 
be carried far without deterioration, except at great ex- 
pense for packing and icing. The size of an establishment 
for the making of butter and cheese suffers under the 
same limitations. The same thing was formerly true of 
the slaughtering of cattle and swine; but in these indus- 
tries a radical change has occurred in recent years. 

For an analogous reason no marked tendency toward 



THE CONCENTRATION OF INDUSTRY 157 

concentration has appeared in agriculture. In that indus- 
try, an important element in success consists in keeping 
the dwelling place of the laborers so near to the fields that 
no great amount of time is wasted in going to and from 
the work. It is also essential that the barns and granaries 
be near enough to the fields to obviate excessively long 
haulage of the products. It follows, then, that the num- 
ber of acres that may be managed from a common center 
is somewhat narrowly limited. An apparent exception to 
this rule is to be found in the great wheat farms of the 
Pacific States, the Dakotas, and the Canadian Northwest. 
Here the land is level and free from stones and stumps of 
trees; the natural fertility is great, and evenly distributed 
over large areas. Cultivation consists simply in plowing, 
sowing, and harvesting, and this can be done by aid of 
the highest type of agricultural machinery. As soon as 
the natural fertility of the soil is exhausted, however, a 
more intensive tillage will be necessary; fertilizers will 
have to be applied; rotation of crops will succeed contin- 
uous wheat-cropping. For such tillage the immense un- 
broken fields are not well adapted. The "bonanza" farm 
is a transient as well as an exceptional phenomenon. 

3. The size of the business unit is further de- 
pendent upon the facilities for marketing 
products. 

Some products deteriorate so rapidly that they cannot 
be produced in large masses and distributed over wide 
areas. Baker's bread will serve as an example of this type 
of commodity. It would be useless to erect a bakery so 
large that it could not find a sufficient market for its wares 
within easy delivery distance. The production of many 
kinds of fresh fruits and vegetables is similarly dependent 
on a local clientele for a market, and the size of the estab- 
lishment is limited accordingly. Some products are 
limited to a narrow local market because they are too 



158 INTRODUCTION TO ECONOMICS 

bulky to justify transportation over long distances. 
Common bricks and firewood fall in this class. In both 
classes, the denser the population, the larger the business 
establishment that can be successfully operated. 

4. Every improvement in transportation and re- 

duction of charges makes possible an increase 
in the size of the average business establish- 
ment. 
Reduction in the charges for carrying wheat and flour, 
both by rail and by water, have resulted in an extraor- 
dinary concentration of the business of grinding grain. 
Low rates on stock cars, and the development of the 
refrigerator car and refrigerator storage on shipboard, 
have made possible the centralization of the slaughtering 
business. Reductions in the rates on furniture have 
enabled Michigan furniture makers to send their goods to 
the most distant parts of the United States. There is 
scarcely a single manufacturing enterprise in the United 
States which has not been brought within reach of a wider 
market by the recent progress in transportation. Mer- 
cantile establishments find their sphere enlarged in 
similar manner. Rapid transit for passengers, and the "ad- 
vent of the motor delivery wagon, have enabled many 
retail stores to expand far beyond the requirements of the 
territory they originally served. 

5. Where industry is carried on by individual 

enterprisers, business concentration depends 

upon the concentration of wealth. 
Before the middle of the nineteenth century the typical 
business enterprise, both in the United States and in 
foreign countries, was owned by a single individual or by 
a partnership consisting of a small number of individuals. 
Large scale enterprise, then, was possible only where indi- 
viduals had gained possession of fairly large fortunes. 
In countries where there was little inequality in wealth, 



THE CONCENTRATION OF INDUSTRY 159 

as in France, the concentration of business could not be 
•so marked as in countries where inequalities were greater, 
as in England. In the newer and more democratic parts 
of the United States, enterprise was conducted on a 
smaller scale than in the older parts, where wealth had 
been accumulated in fewer hands. 

6. The corporate form of business organization 
makes possible a higher degree of concentration 
than is possible under a system of individual 
enterprise. 

A business corporation, or joint stock company, is an 
association of individuals authorized by government to 
carry on an enterprise and endowed with certain special 
privileges, the most important of which is the right to be 
treated in law as a single person. Members of the asso- 
ciation are such by virtue of ownership of shares of stock 
in the corporation. In the simplest form of corporation 
all shares of stock represent equal shares in the control 
of the corporation and equal claims upon its profits. The 
stockholders elect a board of directors and other impor- 
tant officers; employees of minor rank are usually ap- 
pointed by the president, or by the president and directors. 
All business of the corporation is carried on by its officers 
and employees; shareholders, as such, cannot engage in 
business in the name of the corporation 

When a member of a non-corporate business associa- 
tion, or partnership, dies or withdraws from the business, 
it is necessary to wind up the affairs of the association. 
When a holder of stock in a corporation dies, his shares 
descend to his heirs, like any other personal property; 
when he wishes to withdraw from the corporation, he 
merely sells his shares. Changes in the personnel of the 
stockholders do not affect the business of the corpora- 
tion. Therein lies the great superiority of the corporation 
over partnership associations. The former, when not 



i6o INTRODUCTION TO ECONOMICS 

limited by law, has perpetual life, and can therefore 
undertake policies looking to distant gains; the partner- 
ship, on the other hand, is subject to dissolution at any 
time, and is therefore unsuited to large and permanent 
enterprises. 

Wherever the corporate form of organization is well 
established, large enterprises become possible even in 
communities where there are no individuals possessing 
great wealth. A steel plant requiring an investment of 
$6,000,000 may be erected in a city where no man has 
more than $10,000 to invest. Capital secured from a 
thousand different persons thus acquires the same effec- 
tiveness as a vast capital owned by a single individual. 

7. The large establishment can make the most ex- 
tensive use of the principle of division of labor. 

As we saw in an earlier chapter, manifold advantages 
spring from the division of labor. The establishment to 
be launched must be at least large enough to make the 
fullest practicable use of this principle. Perhaps this end 
would be attained, so far as the working force directly 
engaged in the process of manufacture is concerned, in 
an estabHshment with a capital of $100,000 and with 100 
laborers. A second 100 laborers, supphed with an equal 
amount of capital, might double the output, but they 
would not increase the efhciency of the first hundred men. 
So with a third and fourth hundred men. No further 
economy in concentration arises under this head. 

In addition to its manual laborers, the establishment 
must have an "ofhce" force; possibly it may have buying 
agents, who travel long distances in search of the various 
materials, and selling agents, likewise compelled to travel 
about in search of buyers. A small establishment could 
support only a small number of employees of these 
classes; there could be no extended division of labor 
among them. An establishment of larger size might be 



THE CONCENTRATION OF INDUSTRY i6i 

able to assign one man exclusively to the purchase of one 
kind of material, another to the purchase of another kind, 
and so enjoy the advantages of specialized skill. Similar 
division of labor might be effected among the selUng 
agents and among the members of the office force. In 
this way a very large estabUshment could assure itself 
that every commercial situation arising would receive ex- 
pert attention. There is, of course, no theoretical Umit 
to the possible gains from this source. An establishment 
might be so large that it could have a man devoting his 
full time to the purchase of machine oil for its use, and 
something would doubtless be gained through the skill he 
would develop. But in practical life such trifling gains 
would have little effect in determining the size of an estab- 
lishment. They are too small to make a perceptible addi- 
tion to dividends. 

8. In the large establishment it is possible to make 
use of the most perfect mechanical equipment. 

The process of manufacture may involve a score or 
more of manipulations of the material, and at each stage 
several machines may be drawn into use. A number of 
different types of machinery are on the market, some per- 
forming the function required with greater celerity and 
certainty than others. The better machines, naturally, 
represent a larger investment. To equip a factory 
throughout with the best machinery would require a 
large capital, even if the process could be reduced to a 
series of steps occupying one set of machines as long as 
another. Such a division of the process is not ordinarily 
practicable; some machines contribute only very slight 
changes in the material, delaying it but a moment as it 
passes through, while other machines subject the material 
to more important changes and delay it for a longer 
period. In order that the machines may all be used to 
their full capacity, there must be a number of machines 



i62 INTRODUCTION TO ECONOMICS 

engaged in the slower parts of the. process to one engaged 
in the part which can be performed quickly. And this 
involves a still further increase in the capital of the estab- 
lishment. 

In most industries, the general progress of invention is 
in the direction of more costly machines, and this is one 
of the more important reasons for the trend toward in- 
dustrial concentration. At a particular time, however, 
there is a theoretical size of business which permits full 
equipment with the best machines then available. An 
increase in the establishment beyond this point brings no 
advantage in the direct process of manufacture. There 
may, however, be other important advantages to be 
gained through such enlargement of plant. 

9. The large establishment enjoys the advantage of 
cheap power. 

The providing of power, in most manufacturing indus- 
tries, is one of the most important of technical problems 
and here the large establishment usually has decided ad- 
vantages. The larger the power plant, in general, the 
cheaper can power be furnished. There is not so much 
heat wasted in a large furnace as in a small one; a large 
power plant can be so arranged as to prevent much of the 
waste of power in transmission that usually takes place in 
a small establishment. Here it would be difficult to find a 
theoretical limit to the advantages that follow from an in- 
crease in size of plant. In practice, however, the econo- 
mies to be gained in this way are not very important after 
a moderate size of plant has been reached. We do not 
find men constructing huge factories merely to obtain the 
advantages of cheaper power, although these advantages 
are not to be overlooked in determining the size of a busi- 
ness to be established. 



THE CONCENTRATION OF INDUSTRY 1^3 

10. The large establishment ivastes less material 

than the small one. 

In the early history of the American iron industry the 
waste of fuel and metal was enormous. Present-day iron 
manufacturers find it worth while to resmelt the masses of 
slag left as worthless by the early smelters. The increase 
in the size of the blast furnace has reduced by over fifty 
per cent the amount of fuel necesary to produce a ton of 
pig iron. The wastefulness of small scale industry is 
strikingly illustrated in gold production. In one gold 
mining district of Mexico it is estimated that $120,000,000 
worth of metal has gone down into the streams in the mud 
and sand from which the gold is washed. Modern large 
scale methods would have recovered practically all of this 
gold. 

Furthermore, much material which would be absolutely 
useless to the small producer is made to yield a profit to 
the large enterprise which is adequately provided with 
equipment. On the Snake River in Oregon are large 
deposits of gold-bearing gravel, but the amount of gold 
contained in the gravel — about twenty cents per cubic 
yard — ■ would not pay the small producer for the trouble 
of getting it. A gold-dredging enterprise has secured an 
enormous profit — in one year, 128 per cent on its capital 
— from this gold deposit. 

11. The large enterprise can often utilize, for by- 

products, what the small enterprise rejects as 

waste. 
In almost every industry the material undergoes some 
shrinkage in the process of manufacture, through the 
removal of parts not fitted to enter into the main product. 
These parts are waste in a small establishment, and the 
problem of getting rid of them is often a serious one. In 
the large establishment they accumulate in enormous 
quantities, and the question whether they could not be 



i64 INTRODUCTION TO ECONOMICS 

utilized in some way readily suggests itself. Through suc- 
cessive experiments, one element after another ceases to 
figure as waste, and is transformed into a by-product. 
Thus forty years ago much of the residue of the small oil 
refineries was allowed to flow away in the streams. The 
same material to-day is the basis of scores of by-products, 
the value of which is an important element in the profits 
of the petroleum industry. Compare the methods of 
waste disposal of the small butcher shops of tp-day with 
those of the great packing houses. To the former from 
forty to sixty per cent of every animal slaughtered is 
sheer waste, to be got rid of in whatever way the public 
health authorities will permit. This waste in the large 
establishment is transformed into over a hundred by-pro- 
ducts, practically no part of it being considered wholly 
valueless. Such utilization of waste requires the invest- 
ment of a considerable capital in various kinds of appH- 
ances and the employment of a large body of laborers 
who have nothing to do with the main product. Some of 
the by-products take from the mass of waste only insig- 
nificant elements; hence their utilization is possible only 
when waste accumulates in enormous quantities. It is 
obvious that only a very large establishment can carry on 
a thoroughly systematic plan of developing by-products. 
An establishment large enough to enjoy all the advan- 
tages of division of labor and of costly machinery may 
not be one tenth large enough to gain all the profits of 
waste utilization. 

12. The large establishment can secure materials 
at lower prices, and sell its products at higher 
prices, than is possible for the small estab- 
lishment. 

It has already been pointed out that an important ad- 
vantage of the large establishment is the possiblity of or- 
ganizing its buying and selling agents in such a way as to 



THE CONCENTRATION OF INDUSTRY 165 

develop special skill for each kind of transaction. A fur- 
ther commercial advantage consists in the fact that pur- 
chases can be made on a large scale, and therefore, gen- 
erally, on especially favorable terms. The dealer in raw 
material can afford to sell at an unusually low price to a 
customer whose purchases may mount up into millions. 
The same thing is true of all other dealers who supply the 
large establishment. There may, indeed, be a combina- 
tion among such dealers, fixing the margin of profit at 
which each must sell; but such a combination can do 
Httle toward extorting high profits from an enterpriser 
who can, if he chooses, dispense with the middleman 
altogether, and deal directly with the producer of the 
materials. The maker of machinery is likewise compelled 
to content himself with a small profit when dealing with 
a concern which has capital and enterprise enough to 
make its own machinery, if it finds a profit in so doing. 
In its sales, the large establishment enjoys similar ad- 
vantages. It can provide each purchaser with such 
quantities and such qualities as he may desire. If part of 
, the product is to be exported, the large establishment can 
afford to send agents to foreign countries to find out what 
qualities are desired, and in what form the product will 
be most acceptable to the foreign taste. 

The large enterpriser, further, can make a more sys- 
tematic study of the market than can the smaller one, 
and so can make his purchases and sales when the 
markets are most favorable. 

13. The large establishment often enjoys excep- 
tionally low rates on its shipments. 

Since the large enterprise commonly secures its sup- 
pHes, and ships its products, in large quantities, it can 
more frequently avail itself of the low rates on carload 
lots than can its smaller competitors. More important 
still, it can often force transportation companies, in so far 



1 66 INTRODUCTION TO ECONOMICS 

as they are not narrowly controlled by public regulation, 
to discriminate in its favor in fixing charges. . Formerly 
this was done openly by the railways. When laws 
were passsed forbidding discriminating rates, the large 
enterprise was given secret rebates, which often repre- 
sented a very material reduction in rates. This practice 
is relatively infrequent now, but there remain indirect 
methods of gaining favorable rates. There can be 
little doubt that in the past railway discriminations 
have played an important part in hastening the concen- 
tration of industry. 

14. The large enterprise usually pays a lower 

rate of interest on loans than the small 

enterprise. 
No matter how large the capital of an enterprise may 
be, there will at times be need of borrowing money. At a 
particular time the market for materials may be so favor- 
able that it will be profitable to purchase large supplies 
beyond current needs. An active business will not have 
on hand any large amount of idle cash; hence the neces- 
sity for borrowing. As a rule, bankers lend money at a 
lower interest rate to a large enterpriser than to a small 
one. The principal reason why they do this is that the 
large establishment appears to offer better security than 
the small one. 

15. The advantages of business concentration vary 

in their nature from industry to industry. 
The foregoing is of course very far from an exhaustive 
statement of the advantages of the large enterprise as 
compared with the small one. Other advantages will 
readily occur to any one who observes the economic de- 
velopment of the locality in which he lives. It will be 
observed that some of the advantages are prominent in 
one industry, some in another. In the manufacture of 
cotton cloth; for example, there are no important by- 



THE CONCENTRATION OF INDUSTRY 167 

products to be utilized. The market for ordinary grades 
of cloth is well developed; the jobber takes the product 
from the manufacturer's hands and disposes of it to the 
retailer, charging a commission so low that it would 
hardly pay the manufacturer to develop selling agencies 
of his own. Neither the material nor the product is 
very bulky, in comparison with its value; hence the 
advantages enjoyed by the large concern in the matter 
of freight transportation are not likely to be of very 
great importance. To equip a mill thoroughly with the 
best machinery in the market does not require a very 
large capital; nor does an establishment have to be 
very large to enjoy to the full the advantages of division 
of labor. Certain advantages do indeed attend mere size, 
even in this industry; but they are not so important 
that they may not be counterbalanced by slightly better 
management on the part of the smaller establishment. 
In the iron and steel industries, on the other hand, a 
complete equipment of machinery is usually very costly. 
A large capital is required to keep every important ma- 
chine in constant use. The transportation of materials 
and products is expensive, and a great part of the profit 
of an establishment may depend upon the kind of con- 
tract that can be made with the transportation com- 
panies. By-products are not very important, but the 
larger establishment can secure large economies through 
making the best use of its material. Fuel is of course an 
immensely important item in the industry, and decided 
advantages are to be obtained through purchases on a 
large scale. Furthermore, the larger the establishment 
the greater the economy possible in the use of the fuel. 
Accordingly, in this industry a very large plant will 
have substantial advantages over one of moderate size. 
In the meat packing industry, so far as the use of ma- 
chinery is concerned, there is no important advantage 



i68 INTRODUCTION TO ECONOMICS 

enjoyed by the very large plant of which a plant of 
moderate size could not avail itself. Economy of fuel is 
another minor consideration in this industry. The im- 
portant advantages of the large plant consist in more 
systematic division of labor, better utilization of by- 
products, better conditions of transportation, and more 
effective advertising. In the refining of petroleum almost 
every form of advantage that has been mentioned favors 
the large establishment. 

It is not to be inferred that the advantages of the large 
establishment are confined to manufacturing industry. 
Mercantile business shows much the same tendency to- 
ward concentration. In the retail trade, the large estab- 
lishment enjoys great advantages in the purchase and 
sale of goods; it not only buys more cheaply, but it is 
better able to cater to the tastes of its customers than 
the small store. It can afford a style of advertising that 
reaches the public, while the small establishment is likely 
to throw away the money it spends in advertising, not 
succeeding in impressing the conviction of its merits upon 
the prospective customer. 

16. The gains from concentration are subject to 
a law of diminishing returns. 

Theoretically it is difficult to establish a point beyond 
which further enlargement of a business establishment 
would be unprofitable. Every enlargement of a petro- 
leum refinery, for example, makes possible some new 
economies. After a certain size has been reached, how- 
ever, an establishment is able to enjoy most of the known 
advantages of large scale production. In some industries, 
this involves an investment of $500,000; in other in- 
dustries, perhaps, of $50,000,000. A capital of such size 
the enterpriser will vigorously strive to bring together. A 
profitable business may perhaps be conducted with a much 
smaller capital; but it will be more and more seriously 



THE CONCENTRATION OF INDUSTRY 169 

handicapped as time passes, and the average size of new 
competing estabKshments increases. 

There is of course no reason why an estabhshment 
should not be much larger than is necessary to obtain 
practically all the benefits of large scale production 
known at the time. Say that a $2,000,000 plant offers 
all these advantages, there is no reason why a $4,000,000 
or a $6,000,000 plant should not be established. But 
capital cannot be got together without effort; and unless 
substantial advantages are to be gained through the 
larger investment, the enterpriser is likely to rest con- 
tent with the smaller one. 

As we have seen, the expansion of businesses already 
established, in whatever branch of industry, is confined 
to narrow limits by the law of diminishing returns. 
There is a similar law which confines within narrow limits 
the size of a new enterprise in an industry dependent 
upon local supplies of material, or a local market for 
its products. With such enterprises, a point is reached 
where increasing business is attended by increasing cost, 
transportation generally representing the expanding ele- 
ment in cost. Finally, we have the new enterprises in 
industries which are practically independent of local sup- 
plies of material and of the local demand for products. 
In these enterprises we may assume that no element in 
production is as yet fixed. They may, within limits, 
assume such magnitude as will give them command over 
all the economies of large-scale production. These econo- 
mies have a determining importance in the choice be- 
tween a small business and one of moderate size; they 
are of less importance in the choice between an establish- 
ment of moderate size and a large one; with further 
increase in size of establishment their importance dwindles. 
Perhaps there is no point at which further economies 
cease; but there is a point at which they become prac- - 



I70 INTRODUCTION TO ECONOMICS 

tically negligible. In economic language, the economies 
from concentration of industry are subject to a law of 
diminishing returns. 

17. Summary. 

Concentration, or increase in size of the business es- 
tablishment, is a characteristic of the existing stage of 
economic development. A partial explanation of concen- 
tration is to be found in improvements in transporta- 
tion, which make possible the assembling of raw material 
and the marketing of finished products. A prerequisite 
to concentration is the control of great wealth by single 
enterprisers. Such control may result either from the 
growth of large fortunes or from the adoption of the 
corporate form of business organization. 

The advantages of large-scale production are: (i) 
more thoroughly systematized division of labor; (2) bet- 
ter mechanical equipment; (3) cheaper power; (4) util- 
ization of waste; (5) lower prices for materials and higher 
prices for finished products; (6) lower charges for trans- 
portation; (7) lower interest rates. All these advantages 
are subject to a law of diminishing returns. 



CHAPTER X 

BUSINESS COMBINATIONS 

1. In many branches of trade and industry the 
several establishments are united in combina- 
tions that limit in greater or less degree the 
independence of action of each one. 
In the last chapter we saw that the average industrial 
establishment is steadily increasing in size. In some in- 
dustries concentration has already gone so far that a 
small number of establishments control the greater part 
of the output. A movement that is even more striking 
than the concentration of industry is the formation of 
combinations among the enterprisers controlling an in- 
dustry. This movement is, in part, a direct result of 
concentration. When the number of producers be- 
comes small, it is relatively a simple matter to unite 
them for a common purpose. The tendency toward com- 
bination is, however, not a necessary result of concen- 
tration; we may therefore best treat the two movements 
separately. 

Combinations are most frequent in the fields of trans- 
portation and manufacture. Most of the railways of the 
country are combined in a few great systems; the manu- 
facture of steel is dominated by one great combination 
and a half dozen lesser corporations of very considerable 
capital. A similar condition exists in the manufacture 
of illuminating oil, tin plate, sugar, and in a great variety 
of other industries. The production of copper and the 
smelting of silver and gold-bearing ores is largely con- 

171 



172 INTRODUCTION TO ECONOMICS 

trolled by combinations. A combination of great capi- 
talists controls the mining of anthracite coal; in some 
parts of the country the mining of bituminous coal has 
fallen under the domination of combinations. Indeed, 
we may say that the tendency toward combination mani- 
fests itself in practically every branch of economic life. 

2. Combination may take the form of a union 

of producers that, as independent units, would 
be in active competition with one another. 
The combinations that first attracted serious attention 
in the United States were organized in the field of rail- 
way transportation. Two roads, uniting the same ter- 
minals, instead of competing recklessly for business, often 
formed agreements dividing the trafhc on what appeared 
to them an equitable basis. In most of the early in- 
dustrial combinations, the members forming the union 
were engaged in the same stage of the process of pro- 
duction, and hence were active competitors until the 
combination was formed. Such were the steel rail, the 
tin plate, and the wire nail combinations in the iron and 
steel industries. Similar combinations have existed among 
the paper manufacturers, the smelters of the more valu- 
able metals, the distillers, and the binding twine manu- 
facturers. It is associations of this kind that are com- 
monly designated by the term combination. 

3. Combination may assume the form of a union 

between establishments engaged in diferent 
stages in the process of producing and mar- 
keting a commodity. 
One of the earlier phases in economic development was 
the distribution of the various stages in the production of 
a commodity among a number of industries or sub-indus- 
tries. The manufacture of woolen cloth represented sev- 
eral independent industries: washing and sorting wool, 
carding and spinning, weaving, fulling, dyeing. The dis- 



BUSINESS COMBINATIONS 173 

tribution of the product to the various consuming centers 
gave rise to another independent line of business, the 
wholesale trade. The work of placing the finished 
product in the hands of the consumer was taken over 
by another business, the retail trade. 

In recent years an opposing tendency has made its 
appearance. The entire work of preparing and distrib- 
uting a commodity is, in many cases, undertaken in a 
combination of establishments representing a single enter- 
prise. One company mines coal and iron ore, trans- 
ports these materials in its own ships and over its own 
railways, transforms the materials into pig iron for use 
in its own steel plant, and sells the finished product — 
rails, structural material, etc. — directly to the final pur- 
chaser. There are furniture makers that advertise the 
fact that every stage in the process of production, from 
the felling of the tree to dehvery at the customer's 
door, is under their control. Shoe manufacturers own 
the tanneries that supply them with material, and chains 
of retail stores that place the product before the con- 
sumers. This uniting of all the stages in the process of 
production in one combined enterprise is known as the 
integration of industry. Integration and combination in 
the restricted sense often go hand in hand. The United 
States Steel Corporation is a combination of producers 
in the final stage in production, as well as a combination 
of producers in different stages of the process. 

4. Some combinations are temporary in their 
nature. 

Even in an industry which is apparently so unfavorable 
to combination as agriculture, temporary combination is 
becoming fairly common. Farmers often combine for the 
purchase of machinery, seed, or other supplies, or for the 
shipment of their products to distant markets. Simi- 
larly, petty retailers combine in the purchase of goods 



174 INTRODUCTION TO ECONOMICS 

from the manufacturers, thereby gaining the benefits of 
purchasing in large quantities. A number of news- 
papers unite in sending a correspondent to a war or 
other center of popular attention. Groups of financiers 
form combinations, known as ''syndicates," to subscribe 
a loan which would tax too seriously the resources of 
any one. Combination of the nature here described is 
often termed business cooperation. It is to be carefully 
distinguished from labor cooperation, a system under 
which the laborers seek to rid themselves of the control 
of an employer, and from consumers' cooperation, a plan 
by which consumers seek to get rid of the middleman, 
or merchant, and eliminate his profit. 

Another form of temporary combination has for its 
purpose common action in fixing prices. On several 
occasions in the last two decades producers of cotton 
and tobacco have attempted to effect combinations for 
holding out for what they considered remunerative prices, 
and in the period of agricultural depression following 
the Great War similar combinations were sporadically 
attempted by wheatgrowers. Competing railways fre- 
quently agree upon charges for a limited period of time. 
Groups of speculators often combine to force up the 
prices of commodities or securities over which they 
hold a temporary control. 

5. Some combinations, though permanent in nature, 
include in their scope only a small part of 
the activities of their several members. 

In many parts of the country the growers of fruit have 
formed associations for the purpose of controlling the 
marketing of products. In his business as a fruit grower, 
each member of the combination is entirely independent; 
each member endeavors to excel his fellows in quantity 
and quality of output. Long experience of the exac- 
tions of the transportation companies and the commission 



BUSINESS COMBINATIONS 175 

merchants has led to united action in the marketing of 
products. Some of the larger associations have agents 
who visit all the important consuming centers and make 
the most favorable terms with the merchants who deal 
with the consumer. They also have agents whose duty 
it is to watch over the movement of cars bearing the 
products of the association, and to take note of the con- 
dition of the products at the time of delivery. In some 
countries dairymen and poultry producers have organized 
similar associations. 

Most of the newspapers of the country are combined 
for the purpose of gathering news. This work has be- 
come so complex that a paper which cannot avail itself 
of the service of one of the great news gathering com- 
panies, like the Associated Press, operates under very 
grave handicaps. The value of these services is indicated 
by the fact that the mere right to use the service of the 
Associated Press is reckoned at $400,000 in the assets of 
a daily paper in New York City. In every large city the 
banks maintain a clearing house, where the claims of 
the various banks upon one another are settled. So 
important is this function of settlement that a bank 
which is excluded from the clearing house is seriously 
handicapped in its business. In some German industries 
the several establishments, while acting independently 
in the domestic market, maintain common agencies to 
handle the export trade. So advantageous did such 
combined action in international trade appear that Con- 
gress has enacted a law permitting American corporations 
to combine for the . purposes of carrying on business 
abroad. 

In many cases in American industrial history attempts 
have been made to control by combination the aggre- 
gate output of an industry, and so to fix prices. The 
several enterprises were left free to pursue their own 



176 INTRODUCTION TO ECONOMICS 

policies in matters of production; in matters pertaining 
to the marketing of products they were subject to the 
control of the combination. This form we shall consider 
further in a later section. 

6. A combination may merge the several establish- 

ments into a single enterprise. This form of 
combination is known as a consolidation. 
In the great industrial enterprises of to-day, such as 
the United States Steel Corporation, the Standard Oil 
Company, and the American Sugar Refining Company, 
the separate establishments have completely surrendered 
their independence of action. Each establishment has its 
own officers, but these are chosen by the combination, or 
"parent" corporation, which thus determines their polic}^ 
in every important respect. Several hundred combina- 
tions of this nature have been organized. So important 
are these combinations that many persons believe that 
the days of individual enterprise in the field of industry 
are numbered. 

7. The earliest effective form of permanent com- 

bination for purposes of price control was the 
^^pool,^^ an agreement distributing the amount 
of business to be done, or the receipts from 
the business, among the several enterprises. 
In the period following the Civil War competition be- 
came so keen in many lines of business as to force prices 
to the cost level, or even lower. This was especially the 
case in railway transportation. At first an attempt was 
made to maintain rates through formal agreements; but 
each railway, in its zeal for increased business, was 
strongly impelled to cut rates in spite of its agreement to 
maintain them. Various devices were employed to re- 
strain this tendency toward cutting rates. The most 
successful of these were the "pools." A number of 
railways, competing for traffic between two centers, 



BUSINESS COMBINATIONS 177 

would agree upon a division of the traffic (''traffic pools") 
or upon a division of the receipts from the traffic (''money 
pools"). Thus in 1870 the three railways connecting 
Chicago and Omaha made an agreement by the terms 
of which each road was to accept whatever through 
business was offered, at a rate set by mutual agreement. 
Each road was to retain for itself 45 per cent of the 
earnings of the through passenger business and 50 per 
cent of the earnings of the through freight business. 
The remainder of the earnings was to be placed in a 
fund to be shared equally by the three companies. This 
arrangement remained in force for practically fourteen 
years; it was finally destroyed by hostile legislation. 

A similar plan was adopted by the Bessemer Steel Pool 
in 1896. Each mill was assigned a certain percentage of 
the total amount of steel that was to be produced by 
the association. If any mill exceeded its allotment, it 
was required to pay $2 a ton on the excess to the treas- 
ury of the association, and an equal sum was paid 
those members of the association who fell short of their 
allotted output. In this way a restraint was placed upon 
the more active producers, and prices were maintained at 
a decidedly profitable level. This pool, like the great 
majority that were formed, was short-lived. Some of the 
more powerful members became dissatisfied with the per- 
centage of output allotted to them and withdrew, leav- 
ing the pool too weak to maintain prices. 

8. A stronger form of combination was created by 
placing a majority of the shares of stock 
in each constituent company permanently in 
the hands of trustees. This form of combina- 
tion is known as a trust. 
In 1882 the stockholders of the leading petroleum re- 
fining corporations, which had for many years operated 
in harmony under informal agreements, placed a ma- 



V 



178 INTRODUCTION TO ECONOMICS 

jority of their stocks in the hands of nine trustees. For 
the stock surrendered to the trustees, the owners re- 
ceived certificates entithng them to shares in the profits 
of the combination. The power to vote the stock was 
transferred irrevocably to the trustees, who were thus 
in a position to determine the pohcy of each company. 
This form of organization was adopted by several other 
powerful combinations. By a federal law of 1890, known 
generally as the Sherman Anti-Trust Law, the trust was 
made illegal, so far as it affected interstate commerce, and 
most of the states have passed laws prohibiting trusts. 
This form of combination, therefore, has been destroyed. 
9. A permanent combination may be established 
through the formation of a corporation holding 
a majority of the stock in each of the com- 
panies which it is sought to combine. Such a 
corporation is properly termed a holding com- 
pany; in popular speech it it called a ^UrustJ^ 
When the trust form of organization became outlawed, 
men who sought to attain the same end hit upon the 
device of organizing a corporation with power to pur- 
chase and hold the stocks of other companies. Accord- 
ingly, when a group of powerful producers desire to 
form a permanent combination, they secure a charter 
from whatever state happens to be most kindly dis- 
posed toward that sort of business, authorizing the forma- 
tion of a corporation with extensive powers, including 
the essential one of holding stocks in other companies. 
They then exchange their shares in the business corpora- 
tions which they control for shares in the new company, 
and endeavor to induce other persons interested in the 
same industry to do likewise. Or the new corporation 
may place its shares on the market, and use the proceeds 
in the purchase of shares of producing companies. In 
this way it is possible to bring a large part of an industry 



BUSINESS COMBINATIONS 179 

under a single control. The process of thus merging a 
number of enterprises into one is known as ''consoli- 
dation." 

The so-called trusts of to-day are organized in the way 
described above. In some cases the holding company, in- 
stead of buying shares in a producing company, buys its 
plant outright. In many cases it fails to secure a majority 
of the stock in such a company, but secures a sufficiently 
large minority of stock to make its influence decidedly 
felt. For a long time the legal status of the holding com- 
pany was extremely uncertain. The analogies with the 
trust, which had been outlawed, were very close, and it 
was an open question how far the courts would be be- 
guiled by a mere change in appearance. As a fact the 
Standard Oil Company was found unlawful and ordered 
dissolved; the Steel Corporation was judged to be within 
the law. The distinctions drawn by the court are highly 
technical. But it is a fair view of the situation that hold- 
ing companies aiming primarily at control of prices and 
actually exercising control are unlawful, while companies 
aiming at more efficient production are not. 

10. Consolidation increases the productive efficiency 
of the several establishments. 

Where a number of establishments are competing, it is 
to the interest of each to retain exclusive possession of 
such improvements in methods as it may succeed in mak- 
ing. If an improvement consists in a mechanical inven- 
tion that can be patented, the establishment which secures 
it is protected in its monopoly by the law. It is 
conceivable that each one of a score of competing com- 
panies may thus retain exclusive possession of a device 
that the others could use to advantage. Consolidation 
permits each company to make use of all the patented 
devices originating in the establishments of the other 
companies. 




i8o INTRODUCTION TO ECONOMICS 

The United States Steel Corporation erected at Gary, 
Indiana, a steel-making plant which was to embody every 
idea that had proved profitable in any of the plants of 
the company. It was anticipated that steel would be 
manufactured more cheaply at the Gary plant than was 
possible in any other steel works, and with certain quali- 
fications, this expectation has been realized. No com- 
pany not having the combined experience of the Steel 
Corporation could hope to establish a plant of equal 
efficiency. 

The manager of one out of a number of competing es- 
tablishments knows only in a general way what success 
his rivals are enjoying. One establishment may produce 
steel at slightly less cost than another, without attracting 
special attention. When one plant in a great combina- 
tion shows a lower cost per unit of output than do the 
others, the fact is at once known to the officers of the 
combination, who naturally seek to learn the causes of 
this superior efficiency, in order to introduce improve- 
ments in the establishments of less efficiency. Thus in a 
consolidated enterprise there is a resistless tendency to 
force every establishment to keep pace with the one 
which displays the greatest efficiency. 

11. Consolidation encourages a higher degree of 
specialization in production than does the 
system of competitive enterprise. 

An independent establishment, in order to retain its 
customers, is often compelled to cover a comparatively 
wide range of production. This involves keeping on hand 
a large amount of machinery which can be used only for 
a small part of the time. It also involves, in many cases, 
the production of goods for which the supplies of mate- 
rial upon which it relies are not especially well adapted. 
A consolidated corporation can send orders received to 
those plants which are in the best position to execute 
them promptly and efficiently. 



BUSINESS COMBINATIONS i8i 

12. Consolidation makes possible the supplying 
of each customer from the plant nearest to 
him, and thus reduces cost of shipment. 

Where an industry is competitively organized, there is 
a tendency for each producer to invade the territory nat- 
urally belonging to his competitors. Castings for use in 
Alabama should naturally be made in Alabama; castings 
for use in the Pittsburg district should naturally be made 
there. But if there is competition between makers of 
castings in the two centers, some of the products of Pitts- 
burg will be sent to Alabama, and vice versa. This is 
sheer waste, and consolidation puts a stop to it, to the 
advantage of the producer and of society as well. 

It is true that under the competitive regime informal 
agreements among producers to respect one another's ter- 
ritory kept this form of waste within bounds. But there 
was always disputed territory, in which freights were use- 
lessly carried back and forth. Consolidation has elimi- 
nated cross freights, except in cases where real differences 
in quahty make supplying from a distant mill necessary, 
or where the nearest mill is temporarily overwhelmed 
with orders. 

In recent years the benefits from this practice of sup- 
plying customers from the nearest mill have in some 
cases been appropriated entirely by the producer, not 
shared with the consumer. Thus certain steel products, 
though made in Gary or South Chicago, are made to 
bear a price equal to the Pittsburg factory price plus 
cost of transportation to the Chicago district. That is 
obviously a disguised form of monopolistic price fixing. 
It would be impossible if the industry were conducted 
on a competitive basis. 



i82 INTRODUCTION TO ECONOMICS 

13. Consolidation reduces the chances of loss from 
oversupply or undersupply of the market. 

When an industry is carried on by a large number of 
competing employers, each one is in greater or less un- 
certainty as to whether he can market his products at 
remunerative prices. The causes for uncertainty are first, 
possible changes in the demand, over which the industry 
has no control, and second, changes in the combined out- 
put of the competing establishments. When a consolida- 
tion is formed, the second of these causes is eliminated. 
The producer knows exactly how great a volume will be 
placed upon the market. There is consequently less 
chance that huge stocks will accumulate at a time when 
the demand is slackening. When the volume of orders 
increases, the full extent of the increase is readily calcu- 
lated, and preparations may be made for a correspond- 
ingly greater output, if an industry is consohdated. If 
an industry is not consolidated, each producer, although 
receiving an increased volume of orders, is uncertain 
whether the expansion of the business is general or not, 
and so delays preparations for increase of output, with 
the result that at the height of business expansion he 
must turn away orders at profitable prices. 

Herein lies one of the chief advantages of the form of 
consolidation which we have described as industrial inte- 
gration. When the steel industry was competitively or- 
ganized, there was at one time overproduction of ore, at 
another time overproduction of pig iron, at still another 
time overproduction of steel billets, even when there was 
no overproduction in the final stages of the industry. 
Under present circumstances all stages in the industry 
keep pace with one another. If the demand for finished 
products appears to be on the increase, a symmetrical 
increase is ordered in the production of ore, pig iron, 
crude steel, and finished products. 



BUSINESS COMBINATIONS 183 

14. Consolidation reduces the expenses incidental 

to the marketing of products. 

The marketing of products is, in many lines of industry, 
a very complicated process, requiring great expense for 
advertising and for the services of trained salesmen. A 
manufacturer must often make special concessions in 
prices or in conditions of payment in order to introduce 
his goods; under competition he is always in danger of 
losing custom because of the efforts of his rivals to intro- 
duce their goods. Some efforts are of course necessary 
under the most favorable conditions to attract the atten- 
tion of purchasers. But it is manifestly a more difficult 
problem to attract the attention of purchasers away 
from a rival's wares than to attract their attention to the 
general class of goods. Consolidation results in impor- 
tant economies in this respect. In many cases consoli- 
dated companies have been able to dispense entirely with 
the traveling salesman, since purchasers, having no choice, 
are compelled to resort directly to the producer. 

One of the more important sources of loss to the com- 
petitive producer is the failure of purchasers to pay for 
goods secured on credit. The producer can not refuse 
credit, since by doing so he is likely to lose customers. 
The consolidated company can safely insist upon cash 
payment, since it has few competitors to take its custom- 
ers away from it. 

15. The consolidation can usually borrow money 

on more favorable terms than any one of a 

number of competing producers. 
As a result of the manifold advantages of the consoK- 
dated company, the chances of its failure are reduced to 
a minimum. If it is conservatively managed, loans made 
to it possess a high degree of security, and consequently 
bear a low rate of interest. Moreover, the mere fact that 
the consolidation represents a vast aggregate of capital 



1 84 K^TRODUCTION TO ECONOMICS 

places it in an extremely favorable position in the loan 
market. Every one has heard of the Standard Oil Com- 
pany, the United States Steel Corporation, the Harvester 
Trust, the great packing companies. Every one has 
formed an estimate of the financial standing of these com- 
panies. Consequently the man who has loaned capital to 
one of these companies can easily sell his claim upon it 
whenever he desires to regain possession of his funds. A 
small refinery or slaughtering estabhshment may hold a 
position that is financially as sound as that of one of the 
great companies mentioned. But this fact is not generally 
known, and those who loan money to the lesser companies 
find far greater difficulty in disposing of their claims when 
they desire to do so. For this reason they demand a 
higher rate of interest than they would be willing to 
accept from the great consolidation. 

16. The most important advantage arising from 

consolidation is the control over prices that 

it makes possible. 
All the advantages that have been enumerated would 
probably have been insufficient to cause an extensive 
movement in the direction of consolidation. Most of 
them could have been secured through a form of combi- 
nation that would have left the independence of the in- 
dividual establishment practically unimpaired. Combi- 
nations of independent establishments for purposes of 
price control are, under the American system, opposed 
to the spirit of the law, and for this reason could not be 
satisfactorily maintained. In Germany, where such com- 
binations are recognized by law, there was no active tend- 
ency toward complete consolidation until after the war, 
when the disordered state of the whole national economic 
life placed a premium upon every manifestation of power, 
such as the great combinations organized by Hugo 
Stinnes presented. 



BUSINESS COMBINATIONS 185 

It is still a disputed question whether consolidation 
has resulted generally in a material advance in prices. 
There are a number of cases in which it can readily be 
shown that these vast combinations have taken advantage 
of their monopolistic position to maintain prices at a level 
considerably above the competitive level. In other cases, 
consolidation appears rather to steady prices, preventing 
very low and very high prices, than to raise the average 
level. In any event, the rise in prices due to consolida- 
tions has been far less than a consideration of the monop- 
oly position of these aggregations of capital would lead 
one to expect. The checks upon monopoly jx)wer, de- 
scribed in Chapter IV, .appear therefore to be very ef- 
fective. 

17. Summary. 

There is at present a tendency toward the formation of 
combinations of business establishments. The term com- 
bination is properly applied to unions between establish- 
ments in the same stage in the production of a commod- 
ity or service; it is, however, also applied to unions of 
establishments in successive stages in the production of 
a commodity. The latter form of combination is also 
termed industrial integration. Combinations may be tem- 
porary or permanent, partial or complete. The perman- 
ent and complete combination is known as a consolidation. 

The chief forms of combination have been the pool, the 
trust and the holding company. The pool and the trust 
have been outlawed; existing combinations, commonly 
called 'trusts," are of the holding company type. The 
holding company is a corporation whieh holds the stock 
of companies that are consolidated, and so controls their 
policy. 

The advantages of consolidation are (i) the increased 
technical efficiency of each establishment, through appli- 
cation of methods developed in other establishments; 



1 86 INTRODUCTION TO ECONOMICS 

(2) greater opportunity for the specialization of each es- 
tablishment to particular grades of the commodity pro- 
duced; (3) reduction in transportation charges; (4) avoid- 
ance of oversupply and undersupply; (5) reduction in 
cost of marketing; (6) reduction in interest charges; (7) 
control of prices. 



CHAPTER XI 
COMPETITIVE WAGES 

1. Labor is the application of human faculties to 
the production of wealth. 

We have found frequent occasion in earlier chapters to 
touch upon wages and interest. Wages and interest are 
parts of the cost of production of commodities, as we saw 
in Chapter V, and as such have an important part to play 
in determining values. In the present and the following 
chapters we shall endeavor to ascertam the laws deter- 
mining the rates of wages, interest, and whatever other 
forms of social income may remain after the shares of the 
laborer and of the capitalist are paid. In other words, we 
are entering upon a study of the distribution of wealth, 
or, more properly, of the distribution of the social income. 

Every expenditure of human energy having for its chief 
purpose the production or the preservation of economic 
goods, or the increase in the valuable qualities of existing 
goods, is labor, in the economic sense of the term. Labor 
includes not only the exertions of the manual workers, 
by whom actual changes in material commodities are 
wrought, but also the exertions of the foremen, superin- 
tendents, managers, under whose direction the manual 
tasks are performed. It includes the activities of police, 
of judge, and of legislature, upon whose efficient perfor- 
mance rests the possibility of continued production in 
most of the existing branches of industry. Labor does 
not include, however, efforts undertaken for their own 
sake, without regard to economic result. The amateur 

187 



1 88 INTRODUCTION TO ECONOMICS 

football team spends an immense amount of energy, and 
gets its reward in the spending. The amateur hunter 
often cares little or nothing for the birds he brings 
down; his reward is the gratification of the prehistoric 
thirst for blood. The professional football player and the 
professional hunter, on the other hand, are laborers. They 
put forth their efforts for the sake of producing goods 
or services having a definable value and selling price. 

2. Wages are the income received on account of 
labor performed. 

As the term "wages" is generally used, it signifies the 
money or other things of value paid by an employer to 
those who serve him in capacities of inferior dignity; 
employees of higher rank receive '^salaries." Political 
economy does not recognize any such distinction as this, 
based as it is upon the pretended social status of the 
recipient, rather than upon a difference of economic func- 
tion. The ten cents a day paid to a child slave and the 
$100,000 a year paid to the president of an insurance 
company are alike wages in the blunt speech of the 
economist. Moreover, in economic language, the term 
''wages" extends to part of the income of a workman 
who is his own employer. One peanut vender may be 
working for a push-cart enterpriser, receiving three dol- 
lars a day for his efforts. This sum, all will agree, is 
nothing but wages. At the opposite corner of the square 
you may find another peanut vender, who is his own em- 
ployer. The latter may gain, over and above the cost of 
raw nuts, gasolene, push-cart hire, etc., just three dollars 
a day. The two men then receive equal rewards for 
identical services. Possibly the second vender calls his 
income ''profits." Political economy cannot afford to 
use two different terms to designate essentially the same 
thing, especially when one of the terms, "profits," is 
commonly employed in a quite different sense. What- 



COMPETITIVE WAGES 189 

ever a man receives simply as a reward for his exertions, 
whether directly or through the intermediation of an 
employer, is wages. 

3. Contract wages involve more important economic 
problems than does the wage income of the in- 
dependent workman. 

While we cannot properly exclude from the term wages 
so much of the income of an independent workman as 
arises from his personal exertion/ we are nevertheless 
justified in devoting our attention almost exclusively to 
wages as determined by contract between employer and 
employee. An increasing proportion of the world's work 
is being done under this system, and many of the most 
important economic problems of the day are concerned 
with it. Who ever heard of a '4abor problem" in an 
agricultural community where every farmer relies ex- 
clusively on his own two hands? In such a community, 
what importance attaches to the general movement of 
wages, whether upward or downward? Indeed, who can 
determine, in such a society, how much of the total in- 
come of each farmer is wages, how much interest on capi- 
tal invested in the farm? Wages have existed ever since 
our first ancestors were condemned to eat their bread in 
the sweat of their brows; but it is only under modern 
conditions, where one man pays another to work for him, 
that it comes to be of great importance to ascertain what 
laws govern the rate of wages. We shall therefore con- 
fine our study to that part of the economic field in which 
differentiation between employer and employee has 
taken place — where the "wage system" exists — and shall 
endeavor to ascertain the laws operative therein. These 
laws, indeed, exert an influence in the rest of the eco- 
nomic field as well, and are in turn influenced by forces 
lying outside of the field in which the wage system pre- 
vails. What a man could get as his own employer helps 



igo INTRODUCTION TO ECONOMICS 

to determine how much he must have as a mere wage- 
earner; what he could get as a mere wage-earner helps 
to determine what he must gain as an independent work- 
man. 

4. The returns resulting from the employment of 
a given amount of labor vary according to the 
conditions under which labor is employed. 

Let us set before ourselves, in imagination, an agricul- 
tural community in which all the land is owned by a 
small class of men who do not. themselves engage in till- 
age, but hire the landless population to work upon their 
fields. And let us further assume that this population 
is unable or unwilling to migrate to other communities 
in search of employment. Whether there are many work- 
men or few, they must all seek employment upon the 
land, or starve. 

Some of the land in the comniunity is fertile, some of 
it barren. Some of it requires a large expenditure of 
labor for every bushel of wheat or potatoes produced; 
some of it yields rich crops with little labor. Every good 
field yields a moderate crop with a small expenditure of 
labor; if a larger crop is sought, it must as a rule be at 
the expense of a disproportionately large application of 
labor, as we saw in the chapter on Diminishing Returns. 

Accordingly, we may safely lay down the proposition 
that the results arising from the application of labor to 
different fields, and in different methods of cultivation, 
will be unequal. Good land, in extensive cultivation, 
may yield three bushels of wheat per day's labor ex- 
pended, while poorer land yields, perhaps, two bushels, 
and yet poorer land one bushel. Adding one day's labor 
to the amount previously spent on a piece of the best 
land may add only two bushels to the product, and add- 
ing still another day's labor may add only one bushel. 



COMPETITIVE WAGES 191 

5. Equal wages for equal tasks is the rule of com- 
petitive industry. 

However unequal the results of labor on different fields 
and under different methods of cultivation, the reward of 
labor — wages — will tend to be uniform, allowance made, 
of course, for differences in the physical efhciency of dif- 
ferent laborers. Suppose that a farmer has ten fields, of 
different degrees of fertility, and employs one man to cul- 
tivate each, the work on the different fields being uni- 
formly arduous. He would be a very unusual employer 
if he should propose to pay the men different rates of 
wages, according to the fertility of the field upon which 
each is employed. The probable result of such a plan 
would be that competition would arise among the men to 
win the employer's favor, each one desiring to be em- 
ployed on the best field; and in the end we should prob- 
ably find that the better fields would be apportioned to 
the men who would agree to perform for the employer 
various miscellaneous services which would, generally 
speaking, be equal in value to the advantages they en- 
joyed in the way of higher remuneration. How this 
would work out we might consider at greater length if 
we did not know by experience that no employer possessed 
of practical sense is willing to grade the wages of his men 
on any other basis than their personal effort and skill. 
If two workmen of equal skill put forth equal efforts, one 
with an old-fashioned, broken-down machine, the other 
with a new and efficient one, would any employer think 
the one deserved higher pay than the other? Certainly 
not. Cases of unequal rewards for the performance of 
equal tasks are of course to be found; but for these cases 
the explanation, as we shall see later, is of a wholly dif- 
ferent nature. 

Just as uniform wages will be paid for like tasks by any 
one employer, so uniform wages will be paid by all the 



192 INTRODUCTION TO ECONOMICS 

employers in the community. No employer can stay in 
business long unless he pays as good wages as other em- 
ployers. If any one raises wages slightly, he will attract 
to himself an increasing number of workmen, and he will 
soon get all he cares to have. In an earlier chapter we 
saw that there cannot be different prices for the same 
commodity in the same market. This law holds good for 
labor as for anything else one buys or sells. 

6. The wages of any one of a number of laborers of 
equal efficiency will not exceed the addition to 
product made by the laborer whose services 
are least important to the employer. 

Of ten fields, the best one, when cultivated by one work- 
man, may yield a product worth $500; the worst one may 
yield only $150. What will be the maximum wage that 
the employer will pay? Not more than $150. For he 
will not pay any workman more than the entire product 
created by the aid of that workman, and he will not, of 
his own volition, pay one workman more than another. 
Nor can any workman compel the employer to pay him 
more than the one on the worst field receives. Suppose 
that the one employed on the best field insisted on a 
wage of $200. The employer would dismiss him, and 
place on that field the laborer formerly employed on the 
worst field. And so with any one of the ten laborers. 
What the employer would lose, if any one of them should 
leave him, would be simply the product of the worst 
field — ^$150, according to our premises. 

If we assume that the ten fields are owned by different 
men, we arrive at an identical result. The employer who 
owns the poorest field cannot possibly pay more than 
$150 to the workman who tills it. If a workman on a 
better field demands more, his employer will dismiss him, 
and put in his place the workman formerly employed on 
the poorest field, whom he can easily induce to change 



COMPETITIVE WAGES 193 

employers by offering him a trifle more than the owner 
of the poorest field is able to pay. The dismissed work- 
man must live; probably he will have to seek employ- 
ment on the abandoned field, and content himself with 
the wages that the owner of that field can pay. 

If we assume, instead of ten fields of varying fertility, 
one large, fertile field, giving employment to ten men, 
we see exactly the same principle at work. One of the 
men, cultivating the land extensively, may produce $500; 
a second may add to this product $450; a tenth may add 
to the total product of the nine previously employed only 
$150. The employer will not pay the first $500, the sec- 
ond $450, and so on down to $150. He will pay each one 
not more than $150. If any one should demand more, he 
would be dismissed, and his functions performed equally 
well by the man who otherwise would have added only 
$150. What the employer loses, when he loses any man 
of the ten, is the product created by the least important 
one of them all. 

7. The wages of any one of a number of laborers 
of equal efficiency cannot, under competition, 
be permanently less than the marginal product 
of labor, or the addition to product made by 
the laborer whose services are of least impor- 
tance to his employer. 
We have, then, an upper limit of wages above which 
an employer cannot be compelled to go: the addition to 
the total output created by the man who works at the 
greatest disadvantage. Is there, similarly, a lower Hmit? 
In the situation we have assumed — a number of com- 
peting employers, each able to increase his employment 
of men through breaking up new, though less fertile, 
lands, or through more intensive tillage of lands already 
under cultivation — it is unlikely that any employer will 
make a large net return on the last man he employs. 



194 INTRODUCTION TO ECONOMICS 

Let us assume that the uniform yearly rate of wages is 
$120, while the product of the least important man varies 
from $120 on the least fertile farms to $175 on the most 
fertile ones. The man who has a fertile farm can in- 
crease his net income by offering a little more than $120 
for an additional workman. Such a workman will not 
add $175 to the total output — the law of diminishing 
returns forbids this — ^but he may add $170. As the 
employer on the least fertile field secures a product of 
only $120 from his last man, he is compelled to let a man 
go. Perhaps the man who now becomes his least im- 
portant hand is worth $125 to him, and $125 may be 
what the man on the next better field is worth. It still 
pays the farmer with the best fields to seek additional 
hands. The wages he must now offer are more than 
$125, — let us say, $130. And the additional men will 
be worth less to him — ^ perhaps $165 each. Competition 
will still go on between the employers having the better 
fields and those having fields that are not so good, each 
rise in wages affecting, of course^ the wages of all the 
workmen in the community. At last a point is reached 
where no employer can take a workman away from his 
competitor without offering wages so high as to outweigh 
the advantages to be derived from an additional em- 
ployee. Here, then, wages will tend to remain stationary. 
Each employer will be paying his least important man 
so much that any increase in wages would make that 
man an unprofitable member of his working force. No 
employer would care to take on an additional man at 
the existing rate of wages. This means that on every 
farm the least important workman adds to the total prod- 
uct just enough to cover his wages. The addition to 
product made by the man working under the least favor- 
able circumstances is, then, not only the maximum that 
the employer can be compelled to pay; it is also the 



COMPETITIVE WAGES 195 

minimum which he cannot avoid paying. If we describe 
as the "product of labor," that amount of valuable prod- 
uct which is brought into being by the presence of any 
particular laborer, we may say that, under competition, 
wages are determined by the product of the laborer 
working under the least advantageous circumstances (in 
this case, on the poorest land). This laborer is known 
in economics as the marginal laborer, as he is on the 
"margin" or fringe of employment, as it were — in a 
position where his continued employment is almost a 
matter of indifference to the employer, since his presence 
means neither profit nor loss. In the customary eco- 
nomic formula, wages, under competitive conditions, are 
determined by the marginal productivity of labor (i.e., the 
productivity of the marginal workman). 

8. An increase in the number of workers tends to 
reduce marginal productivity and wages. 

Now let us assume that the number of workmen in the 
community is increased by the immigration of equally ef- 
ficient workmen from another part of the country. The 
new men must have employment; and there is plenty of 
work in the community for them to do — on one condi- 
tion, however. They must accept emplo)anent on fields 
yet poorer than any now cultivated, or they must be 
added to the force at work upon the better land, occupy- 
ing themselves with tasks that formerly were neglected. 
In either case they will add less to the product than was 
created by the marginal workman before the arrival of the 
new hands. They must accept a rate of pay lower than 
that which formerly prevailed, else no employer could 
afford to hire them. And as there will not be two rates 
of wages for equally efficient men, the general rate for all 
the workmen originally employed in the community must 
be reduced. If the immigration continues steadily, other 
things remaining the same, the marginal product of labor, 
and with it the rate of wages, must steadily sink. 



196 INTRODUCTION TO ECONOMICS 

If, on the other hand, some of the original landless 
population should move away, some of the worst fields 
would be abandoned, and it would become impossible to 
cultivate the better fields as intensively as before. On 
each field the importance of the marginal man would in- 
crease. If any employer should persist in paying the old 
rate of wages, his competitors, by offering a little more, 
would entice his men away. The tendency for wages to 
rise, with decline in the laboring population, would be 
as irresistible as the tendency for wages to fall with an in- 
crease in population. 

9. Improvements in methods of production tend, as 
a rule, to raise wages. 

Let us suppose that in this community are found exten- 
sive tracts of marshy land of practically no economic 
importance. A competent engineer enters the commu- 
nity, and at a comparatively low expense drains these 
lands and transforms them into the very best quality of 
tillable soil. The owners of the drained lands must have 
labor, and can bid a higher price than prevails generally. 
If the laboring population remains stationary, the effect 
of the new demand for labor is to withdraw men from 
the least favorable situations and place them upon the 
new land. On every farm the product of the marginal 
workman is increased, and wages rise accordingly. If 
immigration of laborers is going on, the new demand for 
labor counteracts the effect upon wages of the new supply; 
if emigration is taking place, the rise in wages that would 
otherwise occur is emphasized. 

A similar influence may be exerted by a general im- 
provement in agricultural practice. It is said that by 
the use of seed corn which has been grown in an isolated 
field from which all barren stalks have been removed be- 
fore maturity, the average yield of corn may be increased 
from ten to thirty per cent. This increased yield is ob- 



COMPETITIVE WAGES 197 

tained without additional labor, excepting a small amount 
entailed by the care of the seed corn field. The use of 
such seed corn in the community we are studying would 
increase the product of every laborer, that of the mar- 
ginal ones as well as that of the rest, and the competi- 
tion of employers with one another would force them to 
raise wages in the measure of the increased marginal 
productivity. The introduction of a new forage plant, 
like Kaffir corn or alfalfa, might have a similar effect in 
increasing the productivity of the marginal laborers. So 
also might the use of a new kind of fertilizer, or the in- 
vention of a new agricultural implement. Almost all 
agricultural improvements, in fact, are likely to have the 
effect of increasing the productivity of labor and the 
rate of wages. 

It is not in the least necessary that such improvements 
find general application. An improvement increasing the 
productivity of labor on one tenth of the farms will gen- 
erally lead to an increased demand for labor on those 
farms. The demand is met by the withdrawal of labor 
from the farms not affected by the improvement; and 
this results in raising the productivity of the least favor- 
ably situated laborers on those farms, and so raises gen- 
eral wages. 

10. A reduction in the rate of interest tends to 
raise wages. 

One other influence needs to be noted here; namely, a 
fall in the rate of interest. There are few farms that 
could not be made to yield a much larger product, if 
abundance of auxiliary capital were to be had at a low 
rate of interest. If a farmer must pay ten per cent on 
borrowed capital or can get ten per cent on his own 
savings if he lends them, he will not build a good barn 
or drain a marsh unless he sees a fair prospect that the 
resulting increase in his income will be at least equal to 



198 INTRODUCTION TO ECONOMICS 

ten per cent on the investment involved, together with 
wages at the current rate for all additional labor required 
in using the improvement. This means that when inter- 
est rates are high a great many opportunities for enter- 
prise and the employment of labor must lie untouched. 
The competition of laborers for the relatively small num- 
ber of jobs available keeps their marginal productivity 
and wages low. If interest falls, one improvement after 
another becomes economically possible and creates new 
opportunities for employment. The demand for labor 
withdraws part of it from the points of least productive- 
ness and raises the general level of wages. 

11. Wages are dependent in part upon personal 
efficiency. 

We have seen that wages must vary with the circum- 
stances in which labor is employed. Whatever the average 
personal efhciency of the workers may be, the rewards of 
labor will tend to rise if the supply of labor decreases 
and to fall if the supply of labor increases. If the capital 
increases and interest falls, wages will rise; if the process 
of production improves through new inventions or better 
management, wages will, as a rule, be raised. But within 
the Hnes drawn by such external circumstances as these, 
wages will vary according to personal efficiency. Whether 
the general level of productivity is high or low, the 
man who can do the work of two will get the reward 
of two, if competition works well. This is commonly the 
case where wages are paid according to the piece rate 
system. Where men are paid by the day or the month, 
it often happens that the more efficient workman gets no 
more than the one who is barely efficient enough to 
keep. But even here there are certain advantages that 
go with superior efficiency. The better man is retained 
when the condition of the market forces a curtailment 
of production. He has more chances of promotion, 



COMPETITIVE WAGES 199 

and of considerate treatment in case of illness or other 
misfortune. Where these disguised rewards are too in- 
significant for consideration, what is Hkely to happen is 
a levelling of efficiency. The man who can do the work 
of two gradually learns how to keep his output down 
to the average. 

The average personal efficiency of labor naturally varies 
from time to time and from country to country, and 
wages vary with it. The average efficiency of the Rus- 
sian farm laborer in the time before the Great War 
was remarkably low as compared with that of the Amer- 
ican farm laborer. The defective equipment of Russian 
agriculture had much to do with the inferiority of labor, 
but the spirit of the laborer and the intelligence with 
which he directed his efforts bore also their share of the 
responsibility. That this was true was demonstrated 
clearly in the case of Russian farm laborers who emigrated 
to America. It was a matter of several years to bring 
them up to the American standard of quickness of move- 
ments and intelligent application of physical strength. 
Most immigrants to America have found at first that 
much more effort was expected of them in America than 
in Europe or Asia. This superiority in personal efficiency 
is one of the factors making for the superiority of the 
American wages level. 

High personal efficiency is a cause of high wages, but 
it is also frequently an effect of high wages. When wages 
are so low that the worker can afford no other food than 
a bowl of rice, it would be foolish to expect the same 
capacity for hard physical labor as may be found where 
wages are high enough to give the worker a rich and 
varied diet. It has long been known to railway builders 
that it is impossible to get as much work out of East 
Indian coolies as can regularly be got out of occidental 
laborers. Although American railway laborers may be 



200 INTRODUCTION TO ECONOMICS 

paid ten times the wages of laborers in India, the wages 
cost of constructing a mile of track in America will 
probably not exceed three times the cost of constructing 
a mile of track over a similar terrain in India. Where 
the initiative of the laborer is drawn upon more heavily, 
the superiority of the higher paid labor is likely to be 
still more pronounced. There are relatively few modern 
industries that can be advantageously transplanted from 
high wages countries to those in which low wages prevail. 

The effect of high wages in increasing efi&ciency makes 
itself felt in a very short time. Japanese and Hindu 
immigrants in the Pacific States quickly respond to 
American conditions and put forth efforts beyond the 
measure of which they were capable in their countries of 
origin. But the full effect of high wages requires a gen- 
eration or more for its development. In a region of high 
wages children are well fed, warmly clad and comfortably 
housed and grow up sounder physically and more alert 
mentally than the children born in a region of low wages. 
As a rule, the children of immigrants in America are 
physically superior to their parents and capable of devel- 
oping greater economic efficiency. Often, to be sure, they 
lack the industry and patience of their parents and fail 
to make their superior advantages count. But this is 
very far from the general rule. 

12. In a complex industrial society, laborers fall 
into many classes between which there is no 
direct competition. 

We may now sum up the results of our study of wages 
under the assumed conditions. Wages are determined by 
the marginal productivity of labor, but marginal produc- 
tivity itself is subject to many and varied influences, 
such as arise from increase or decrease in number of 
laborers; increase or decrease in the amount of available 
land; the progress of improvements; the fluctuations in 



COMPETITIVE WAGES 201 

the interest rate; changes in the personal efficiency of 
labor. Let us now see how far we can apply the same 
reasoning to the determination of wages under conditions 
more like those of modern industry, confining ourselves, 
however, to those parts of the industrial field in which 
competition exists among employers on the one hand 
and among workmen on the other. 

The first fact that we must take into consideration is 
that we cannot assume that in this wide field of industry 
every workman can enter into direct competition with 
every other workman, and thus bring about an immediate 
equalization of wages. The journeyman tailor cannot be 
replaced by the excavator nor by the farm hand; the 
cotton-mill operative cannot take the place of the iron 
and steel worker. At any given time, then, there must 
be many rates of wages, not one universal rate. 

As we enter upon a study of the forces which are 
responsible for the differences in wages in the various 
trades and occupations, we encounter a difficulty which 
has not hitherto arisen to vex us. How can we say what 
differences in general rates really exist? In all our dis- 
cussion up to this point, we have spoken of equal re- 
wards for equal services. Of course if one bricklayer 
does twice as much work as another, he is likely to re- 
ceive twice the wages. But if a tailor receives twice the 
wages of a bricklayer, how can we say that it is because 
he does twice as much work. What common measure 
can we find for tailor's labor and bricklayer's labor? 
There is none. 

13. Through the apportionment of new additions 
to the working force, wages in different 
occupations requiring equal natural endow- 
ments tend toward an equality. 

Let us suppose that there are half a dozen occupations 
in a community, all of which require of beginners about 



202 INTRODUCTION TO ECONOMICS 

the same degree of intelligence, dexterity, and strength, 
although they differ as widely in their nature as brick- 
layer's and tailor's labor, so that no direct comparison 
of wages is possible. Is there any reason why differences 
in wages per day should exist? At first, we should expect, 
the choice of occupations would be more or less a matter 
of chance. A boy would enter one of the trades be- 
cause his father followed it; another, because his best 
friend intended to enter it, and so on. 

Once in the trade, a man would have to remain there, 
unless he wished once more to go through the tedious 
tasks of a beginner. The different trades would thus be 
walled off, as it were, one from the other. Mature reflec- 
tion might convince a man that he had made a mistake 
in choosing his trade; but this would not mend matters. 
His earnings would be wholly subject to the laws of his 
trade. If many men happened to be in the trade, and 
the demand for their services was limited, some of them 
would have to be set at unimportant tasks, which could 
not be well remunerated. And competition among the 
men would force wages down to the level of remunera- 
tion of these. If the trade were but scantily supplied 
with men, all might be employed at work that could pay 
a high reward, and so a high rate of wages would prevail. 
In each trade the rule that marginal productivity de- 
termines wages would apply; but marginal productivity 
would be unequal, for men of equal native ability, in 
the different trades. 

In every trade, however, a constant supply of new re- 
cruits is necessary to keep its ranks full, and the pros- 
pective apprentice has a certain measure of freedom of 
choice. In one trade, he finds men discontented and im- 
poverished; in another trade, he finds every appearance 
of prosperity. Unless he is very blind, he will choose a 
trade in which the latter condition prevails. So the tide 



COMPETITIVE WAGES 203 

of apprentices sets steadily away from the underpaid 
trades, and in the direction of the better paid ones. 
Faihng numbers, in the former trades, raise the marginal 
productivity of labor; increasing numbers, in the more 
prosperous trades, reduce wages there. Whether this pro- 
cess will continue until perfect equality of rewards is 
established for men of equal native ability in different 
trades, we cannot say. The equalization depends upon 
the good judgment of the prospective apprentices in 
their choice of trades; and these, Hke all men, are likely 
to err. But gross inequality, under the circumstances, 
could hardly long persist. 

14. Permanent differences in competitive wages 
correspond with differences in the marginal 
productivity of labor, originating in in- 
fluences affecting the distribution of the 
supply of labor. 
Some of the differences in wages actually existing ap- 
pear to be fortuitous, as those assumed in the forego- 
ing example. But many of these differences are clearly 
connected with the personal qualifications of the work- 
man — his strength and skill, his intelHgence and relia- 
bility. Others are connected with the different degrees 
of risk, agreeableness, and dignity of the employment 
itself. Still others depend upon trade union require- 
ments or legal restrictions. What we are concerned with 
here, however, is not to classify the causes of differences 
in the wages paid in different occupations, but to see 
exactly how . these causes operate. 

We know, for example, that a dangerous occupation 
is likely to carry with it a higher remuneration than a 
safe one; that an occupation requiring a long apprentice- 
ship is ordinarily better paid than one requiring prac- 
tically no training. Why may we not say, then, that a 
part of a man's reward is for labor, part of it for risk? 



204 INTRODUCTION TO ECONOMICS 

If a tedious apprenticeship is necessary, may we not say 
that part of the reward of the journeyman is a com- 
pensation for the time and trouble spent in learning the 
trade? Such an explanation would be quite satisfactory 
if we actually found that, other things equal, wages were 
nicely graded according to risk or to the length of the 
period of apprenticeship — if, for example, we found that 
a workman in an occupation involving no appreciable 
risk received wages represented by x, an equally effi- 
cient workman in an occupation involving a consider- 
able risk received x+y, and a third workman, in an 
occupation twice as dangerous as the second, received 
x-\-2y, and so on. But we do not find in real life 
any such simple rule as this. Dangerous occupations, 
we often find, are very ill paid in comparison with occu- 
pations requiring no greater natural ability and entail- 
ing no risk worth speaking of. Almost the least remun- 
erative occupation that an able-bodied citizen of the 
United States can engage in is that of soldier, and this 
in spite of the fact that the Federal government prides 
itself upon being a liberal employer. Certainly the risks 
of the occupation are considerable. Trainmen on the 
American railways incur far greater risks of injury and 
violent death than most workmen in factory industry, 
the hand trades and commerce. Yet we do not find 
that railway men are better paid than other workers of 
equal skill, intelligence and energy. What we really find 
is that in some cases no allowance appears to be made for 
risk; in more cases some allowance is made for it, but 
there is no apparent tendency for this allowance to vary 
regularly with the degree of risk. Similarly with differ- 
ent degrees of skill. Ordinarily, the skilled laborer, who 
has undergone a long apprenticeship, receives a higher 
reward than the unskilled laborer of equal native in- 
telligence. In some cases, however, this does not appear 



COMPETITIVE WAGES 205 

to hold true; and it is idle to attempt to show that there 
is any ascertainable proportion between degrees of skill 
and differences of remuneration. So also with disagree- 
ableness of work. Little, if any, allowance is ordinarily 
made for it in wages, although in some cases it seems 
to play a very important part. Clearly, then, it is not 
enough to say that wages are affected by risk, by skill 
required, by disagreeableness of occupation. We must 
know how these causes operate, and why they operate 
with such irregularity. 

Let us see if a concrete example wiU not make clear 
the relation risk actually bears to wages. Imagine that 
a gunpowder factory is erected at a distance of a few 
miles from a city of some size, and let us suppose that 
five hundred workmen will be required, and that they 
will be of a grade of skill that would command an 
average of $5 a day in perfectly safe occupations. How 
much will it be necessary to add to this sum, to induce 
them to enter the powder works? 

Now, the first question that is Kkely to be asked is. 
How much danger is there that the works will blow up? 
You do not know this, neither do I; nor, we may venture 
to say, do the workmen whom it is sought to employ. 
Perhaps there is no danger at all in the present stage of 
the powder manufacture. Powder mills have often blown 
up, however, and most of us would prefer to stay out of 
them. 

In every community there are some men who do not 
seem to be in the least afraid of danger. They may 
know that destruction has befallen others, but, each 
argues, everybody can't be killed; why should I be? 
Such men have supreme confidence in their luck. Dan- 
ger, real or imputed, does not influence their conduct. 
Now, if there are a thousand men of this kind in the 
city, it will be quite possible . to man the powder mill 



2o6 INTRODUCTION TO ECONOMICS 

without offering any more of an advance in wages than 
would have to be offered by an enterpriser who pro- 
posed to estabhsh a new shoe factory or nail mill. The 
powder manufacturer, as any one else starting a new 
enterprise, will offer wages a little higher than those 
prevailing in the city — twenty-five cents more per day, 
perhaps. Not every one will jump at the chance to im- 
prove his wages; but the men who despise danger will 
one by one leave their former employments and enter the 
doors of the powder mill. Presently wages will be re- 
duced to the general level. No man will for this reason 
leave the mill, nor need the enterpriser care if a few 
should do so, for there are still plenty of men in the city 
who are not disturbed by fear of accident. 

But suppose that instead of one thousand such men, 
there are only one hundred. The powder manufacturer 
will find that twenty-five cents extra a day fails to bring 
the full complement of men. Perhaps he will offer fifty 
cents extra; and this may bring another hundred men, 
who fear for their lives, indeed, but desire the additional 
income extremely. An additional twenty-five cents may 
bring another hundred, more timid or less eager for high 
wages. At the rate of $i a day above the prevailing 
rate, the enterpriser may be able fully to man his works. 

Now, we may ask ourselves, is this extra dollar a com- 
pensation for risk? Remember, there may be no real 
risk at all, and it may be that it is nothing but the name 
of powder that has kept the workmen back and forced 
up wages. And how is it that a powder manufacturer is 
able to pay men for risk, at their own estimate — • very 
likely a mistaken one, too? Well, the powder manu- 
facturer is experiencing the ordinary incidents of his busi- 
ness. Everywhere powder manufacturers have to con- 
tend with the same indisposition on the part of the 
ordinary workman to enter their mills. Everywhere the 



COMPETITIVE WAGES 207 

amount of available labor is limited, relatively to the 
demand for it. And so the productivity of a laborer, 
measured in value of powder produced, is high, and 
wages may be high accordingly. If, however, the number 
of men who do not miiid the danger were sufhcient 
fully to man all the powder works, more powder would be 
produced, its value would be less, and the productivity of 
labor, in value, would fall until it corresponded with that 
of labor in other occupations requiring equal skill. 

If the risks to life and limb undergone by locomotive 
firemen and engineers were reduced by fifty per cent 
through the introduction of better safety appliances, the 
improvement of track, etc., how much could wages be 
reduced? I have never heard of a railway president who 
proposed to spend the company's money in reducing the 
chances of accident with the expectation that part of the 
cost might be met by a reduction in wages. Nor do we 
find that wages are especially high in the sections of 
the country where transportation is conducted at the 
greatest cost in life and limb. 

In recent years there has been a tendency in every 
country to saddle the risks of injury and death upon 
the employer through workingmen's compensation laws. 
Where these laws have attained to their full development, 
every injury to a workman not the result of gross neg- 
ligence on his own part has its price. Have employers 
been able to reduce wages as an offset to the new burden 
imposed upon them? Not at all. And now when the 
employer actually has to bear the burden of accidents, 
he finds it to his business advantage, as he never did 
before, to install all manner of safety devices. But the 
installation of safety devices is nowhere accompanied by 
a reduction in pay. Laborers did not as a rule, demand 
pay for risk. They will not cut their ordinary demands 
when risk is reduced. 



2o8 INTRODUCTION TO ECONOMICS 

15. The standard of living affects wages directly 
through affecting efficiency and indirectly 
through affecting the supply of labor. 

What one requires to live on in accordance with one's 
established conceptions of comfort and decency is one's 
standard of living. Since most men have families to 
provide for, the standard of living is usually conceived 
in terms of the requirements of the average family unit. 
It is in this sense that we shall conceive it here. 

So conceived, the standard of living would appear at 
first to be something extremely variable and fluctuating. 
Each family will have requirements differing from those 
of every other family. One family must have a spacious 
house in order to consider life worth living; another 
family can be happy in an apartment of three rooms. 
One family is certain that the world owes it a Rolls- 
Royce car; another feels favored of Providence if it can 
command any kind of rattling old car that will make a 
hill and hang together for the descent, and a third feels 
lucky if it can spare the sums necessary for occasional 
excursions by street car or bus. 

When standards of consumption are so individualistic 
as in the cases cited they are of very little economic 
significance. There are standards, however, that are of 
a more general character. In a working class community 
there are certain standards of housing, clothing and food 
that one must live up to if he wishes to escape the 
pity and contempt of his fellows. These standards 
differ for different classes of labor. The skilled work- 
man must make a better showing than the unskilled 
worker; the clerk must make a better showing, at least 
in clothing, than the skilled laborers; the professional 
man must make a still better showing; the business man, 
above all, must live in a way to offer presumptive evi- 
dence of prosperity. Wherever men live in sufficiently 



COMPETITIVE WAGES 209 

close association to be concerned about " appearances," 
there are standards of consumption formed or in process 
of formation. 

Standards of living vary widely not only- from class to 
class but from country to country. In America, for 
example, abundant wheat bread and sugar, and the 
daily consumption of fresh meat are parts of the stand- 
ard of living of the average workman. In Japan rice, 
with occasional fish, is counted a sufhcient diet. Leather 
shoes are an essential part of even the lowest American 
standard. In parts of Europe wooden shoes are regarded 
as satisfactory by the rural laborer and by some of the 
poorer classes in the towns. If we take as our base of 
comparison the standard of the ordinary laborer, we 
should find that in America it involves, on the whole, 
a greater command over the comforts and necessities of 
life than in any older country. Put in simple terms, it 
costs the American workman more to live than it costs 
the workman of France, Italy, Japan or China. 

How does the standard of living affect the rate of 
wages ? We have already seen that high wages may be 
a cause, instead of a result, of high personal efhciency. 
The workman who has been accustomed to wages high 
enough to provide his family with nutritious food, com- 
fortable clothing and hygienic housing is able and willing 
to work harder than the workman who is reconciled to 
seeing himself and his family half starved and in rags. 
The former is more likely to bring his children up to a 
high standard of efficiency than the latter. And thus a 
standard of living, whether high or low, tends to be 
transmitted from generation to generation. The high 
standard of living became established in America when 
the wealth of virgin land offered a comfortable living to 
everyone strong enough and energetic enough to occupy 
it. And the standard thus established has survived the 



2IO INTRODUCTION TO ECONOMICS 

epoch of free land chiefly because it has been translated 
into personal efi&ciency. 

The indirect influence of the standard of living is 
bound up with its actual or possible control of the supply 
of labor. So long as immigration was unrestricted, every 
period of prosperity and rising wages was characterized 
by a heavy influx of immigrants. At such times aliens 
already established in America would write to their 
kindred and friends of the high wages and pleasant con- 
ditions of employment they had found here. The heavy 
immigration resulting had the effect of checking the rise 
in wages, but did not immediately lower the standard 
of living. In the ensuing period of depression, when 
earnings proved insufficient to maintain the standard of 
living easily, a note of discontent and distress from the 
American working class was heard across the seas and 
checked the flow of immigration, for the time. If the 
American workman had been without standards, reconcil- 
ing himself to low wages when high wages were no longer 
to be had, it may be assumed that immigration would not 
have felt the effect of his discontent until the wages levels 
of Europe and America had been fairly equalized. 

The most potent influence of the standard of Hving, 
however, is exerted through its influence upon the growth 
of population. In a country where the average age of 
marriage is low the natural growth of population is 
likely to be very rapid. In the colonial and early national 
periods of American history, the population doubled by 
natural increase every twenty-five years. Such a rate of 
increase, at that time, was not incompatible with a 
steadily rising level of comfort. But it is plain that it 
could not continue indefinitely in any country without 
producing the severest pressure upon -the means of pro- 
duction and consequent poverty among the most num- 
erous classes of the population. 



COMPETITIVE WAGES '211 

When standards of living are firmly established the 
tendency of population to increase beyond the means of 
subsistence meets a check short of universal poverty. 
Men will not marry and rear children unless they can 
foresee a fair possibility of maintaining the standards of 
living to which they are accustomed. The average age 
of marriage will be raised and the birth rate will be 
reduced. Where the standard of living of the working 
class includes nothing beyond the barest subsistence, as 
in China and India, there appears to be no escape from a 
state of extreme poverty for the masses of the population. 

The standard of living exerts a powerful influence upon 
wages, as we have seen. But whether it operates directly 
or indirectly, it operates through the productivity of 
labor. In its direct operation, this relation to pro- 
ductivity is too evident to require further discussion. In 
its indirect operation, the relation is easily seen. The 
standard of living prevents that indefinite increase in 
the labor supply that would thrust the margin of pro- 
duction into barren fields, into the leaner mines, into in- 
dustries of low utiKty, where only low wages could be paid. 

16. The special standards of living of the various 
professions and trades operate, as a rule, 
only indirectly and uncertainly. 

If you are planning to become a physician, you are 
likely to seek the counsel of some who are now practic- 
ing the profession. You will probably receive some such 
advice as this: "Whatever you do, don't make a physician 
of yourself. A physician must dress well; he must Hve 
in a good house; he must keep a car; in short, he must 
live at great expense, and, in the majority of cases, he 
will find great difficulty in obtaining an adequate in- 
come." Now, what this means is that physicians have 
a comparatively high standard of living, and that their 
average incomes are scarcely sufficient to meet all the 



212 INTRODUCTION TO ECONOMICS 

demands upon them. You may not be deterred by the 
doleful account of the physician's financial difficulties. 
But is it not probable that, in the length and breadth 
of the land, hosts of young men are in this way turned 
to other professions? If, on the other hand, the majority 
of physicians were recommending their profession as one 
in which a good Kving was assured, is it not likely that 
many young men would be attracted to the profession? 
In the former case the average income of the physician 
would be likely to be increased by the growing scarcity 
of competent medical men; in the latter case it would 
be likely to be decreased by increase in numbers. 

If, then, the earnings in a profession or trade are not 
sufficient to command, on an average, the necessaries 
and comforts that are deemed essential to happiness, a 
certain influence is exerted upon those entering the pro- 
fession or trade, and thus upon the level of earnings. 

In the example just given, the effectiveness of the 
standard of living in one profession depended upon the 
absence of a similar standard in other professions. Sup- 
pose that after getting the opinion of a physician as to 
the advisability of entering his profession, you apply to 
a lawyer for his opinion on law as a profession. '' What- 
ever you do, avoid the law," he will probably tell you. 
Next, you go to one who has chosen journalism. '^I 
pity a young man who selects journalism as his pro- 
fession," is probably what you hear. Then you go to 
a teacher. He shakes his head. "If I were a young 
man, I should choose some other profession." Indeed, 
if you do not happen upon one of the few optimists who 
still survive, you are likely to conclude that you may as 
well choose the profession toward which you were origi- 
nally inclined, since all professions seem to be inade- 
quately paid. The fact is that most of us think that we 
need more than we get; and the result is that no one 
profession is able to frighten aspiring youths into choos- 



COMPETITIVE WAGES 213 

ing some other line of activity. We cannot therefore 
say with any certainty that such differences as we find 
in professional and craft earnings are determined by 
antecedent differences in the standard of living. 

17. Summary. 

In the widest sense, wages include all incomes orig- 
inating in labor. In a narrower sense wages are the 
price paid by one person for another person's services. 

While the productivity of labor varies with the con- 
ditions under which labor is employed, wages for tasks 
of equal difficulty tend toward a uniform level. This 
level is determined by the addition to product made by 
the laborers who might be most easily dispensed with, 
or the marginal laborers. 

Wages tend to rise or fall with increase or decrease 
in the personal eiffciency of labor. An increase in the 
labor supply, other things equal, reduces wages. Im- 
provements in production usually tend to raise wages, 
as does also reduction in interest rates. 

There is little direct competition between laborers in 
the several occupations; but the apportionment of the 
supplies of new labor tends to prevent any great ine- 
quality in the rewards of men of equal natural ability. 
Permanent differences in wages are the result of barriers 
preventing the free flow of labor from one field to an- 
other, such as a long period of apprenticeship, risk, trade 
regulations. 

The standard of living affects wages, directly and in- 
directly, through affecting productivity. A population 
living on a high standard is more efficient, as a rule, 
than one living on a low standard. A high standard 
tends to check the growth of population whether by 
immigration or by natural increase, and so prevents the 
supply from outrunning the means of employment and 
subsistence. 



CHAPTER XII 
WAGES AS AFFECTED BY LABOR ORGANIZATION 

1. In industry at large the forces of productivity 
and competition are paramount, in determin- 
ing wages. But organization is necessary 
to place labor and capital on a parity in 
bargaining. 
In the last chapter we saw that wages, in so far as 
they are determined by competition, tend to conform to 
the productivity of labor. It was recognized that com- 
petition works uncertainly, tardily and even in cases 
injuriously. Low productivity and low wages temporarily 
established in an industry by competition may conceiv- 
ably produce a permanent lowering of efficiency, with 
the result that the low wages may become permanent. 
None the less it was maintained that in the large, and in 
the long run, there can not be a wide gap between wages 
and marginal productivity. And the reason is that every 
employer who is incurring loss will reduce his working 
force while every employer who makes an important net 
gain on his marginal labor will try to increase his working 
force, and the competitive tugging and hauling of em- 
ployers on the one side and workers on the other will 
force wages toward the productivity level. 

But as we look around us in industry to-day, do we 
see competition working in this way to determine wages? 
Do we not rather see a body of employers doing their 
best to keep wages down and a body of organized work- 
men trying to raise them? And does not this observation 

214 



WAGES AFFECTED BY LABOR ORGANIZATIONS 215 

incline us to the view that wages are determined by 
struggle, and will be high or low according as the one 
side or the other is the better organized and the more 
competently led? It would not be unnatural if we inclined 
to this view. But we ought to bear in mind that in 
economics there is often something very deceptive about 
first appearances. Let us see whether we can not gain a 
surer insight from an examination of the results of the 
greatest economic experiment of our time, the industrial 
movements of the Great War. 

After an initial period of demoralization, prices in the 
United States began slowly to respond to the increasing 
demands of the belligerent nations. Placing the average 
prices of 1913 at 100, average prices in 1914 were 100.6, 
in 1915, 102.5, in 1916, 1134, in 1917, 136. i, in 1918, 
160.8, There was naturally great irregularity in the 
operation of this price increase. Some commodities rose 
hardly 25 per cent, others more tlian 200 per cent, but 
practically all commodities rose in some measure. If 
wages could have been kept at the 19 13 level there 
would have been huge profits for employers as a class. 
But wages could not be kept there. According to the 
calculations of the Bureau of Economic Research, pub- 
lished in ''Income in the United States," average annual 
wages for all employments rose from $723 in 1913 to 
$1078 in 1918. 

What made wages rise? It may be said that wages 
went up automatically because prices went up. It cost 
the laborer more to live; therefore he had to have more 
wages. But the matter is not so simple as that. There 
is no general arrangement between employers and em- 
ployees under which wages are marked up whenever the 
cost of living rises. Left to himself the average employer 
Will not add a penny to wages on account of increased living 
costs, unless it appears profitable, or unless he is compelled 



2i6 INTRODUCTION TO ECONOMICS 

to do so. The greatest employer in the United States, 
and we should suppose, the most generous and public 
spirited, is the government itself. How much did the 
government raise wages in this period of mounting living 
costs? Six per cent; and the increase in living costs was 
more than 60 per cent. Compare this increase in govern- 
ment wages with 80 per cent for agriculture, 78 per cent 
for railways, 70 per cent for mining, 63 per cent for 
factories, 60 per cent for the hand trades. Is it not 
sufhciently clear that the rise in wages can not have 
been an automatic response to rising living costs, nor a 
mere exercise in generosity on the part of the employers? 

Wages rose either because the labor organizations forced 
a rise or because the employers found it profitable to 
raise them. Of these two possible explanations, which 
looks the more plausible, on the face of the figures? The 
greatest percentage of increase occurred in agriculture, 
where there is practically no organization. The next 
greatest occurred in railways, where the organizations are 
very strong. The hand trades are better organized than 
the factory workers or the miners, but their wages ad- 
vanced only 60 per cent, as compared with 63 and 70. 

What really happened was this: As the war demands 
developed, the industries catering to those demands found 
that they could make enormous profits if they could 
supply products in sufficient quantity. In order to do 
this they had to have more labor, and they proceeded 
to bid for it whatever price was necessary. They drew 
labor away from other industries not yet affected by war 
demands, and forced employers in those industries to 
choose between raising wages or closing down their shops. 
Where labor was well organized it was quick to perceive 
the fact that the employers could be made to pay more, 
and presented demand after demand. Usually it got 
what it demanded. 



WAGES AFFECTED BY LABOR ORGANIZATIONS 217 

As the foregoing account shows quite conclusively, the 
primary force making for higher wages, both in the or- 
ganized and the unorganized employments, was the in- 
creased demand for products and the high prices. In 
money terms, labor was worth more to the employer. 
He did not want to pay more, but he had to do so, or 
gradually lose his men to other employers, or still worse, 
find a strike on his hands. 

War economics is, of course, pathological and we 
should fall into grave error if we applied the results of 
our study without qualification to the conditions of 
peace. We are, however, justified in drawing the infer- 
ence that the forces of productivity and competition 
operate even under conditions of organization. They set 
limits, not easily defined, to be sure, to the efforts of 
organized labor to raise and of organized capital to depress 
wages. But within these limits there may be considerable 
latitude for combined action, on either side. 

2. A labor organization may conceivably increase 
the wages of its members (a) at the expense 
of some other participant in the productive 
process or of the consumer, or (b) through in- 
creased efficiency without cost to anyone. 

Let us assume that all the labor engaged in the manu- 
facture of shoes is united in a hard and fast organiza- 
tion, powerful enough to prevent anyone not a member 
of the organization from working. And let us assume 
further that the organization has decided to raise its 
wages ten per cent. Who will meet this additional cost? 

Of the net value product of our manufacturing indus- 
tries about three fourths is paid out in wages and salaries. 
Or to put it specifically, in the period from 1909 to 
1918, the share in the value product paid out in wages 
and salaries ranged from 68.7 per cent in 191 6 to 77.8 
per cent in 19 14, according to "Income in the United 



2i8 ' INTRODUCTION TO ECONOMICS 

States," already cited. Now it is possible that an addi- 
tional ten per cent for labor could be drawn from the 
twenty-five per cent of the value product retained by the 
employers as profits and interest on capital. But unless 
the industry is enjoying an especially favored position, 
such a reduction in the share of the employer would 
bring his returns below the prevailing level and drive 
capital out of the industry. 

If capital is driven out of the industry the volume of 
product will shrink and its price will rise. Thus part of 
the additional charge for labor will be passed on to the 
buyer of shoes. The demand for hides and skins will be 
reduced and their price will fall. Thus part of the ten 
per cent increase will be reflected back upon the suppliers 
of these materials. We could pursue the analysis farther, 
to show how the burden would be diffused among the 
tanners, the butchers, and the cattle men and how, fur- 
ther, it would be distributed between labor and capital. 
But we need not trace out these ramifications. It is al- 
ready sufficiently plain that the question of the ten per 
cent increase in wages does not lie exclusively between 
the employers and employees, in the shoe manufacturing 
industry alone. It may be one of far wider concern. 

But neither the employer nor the general public is 
concerned primarily in wages per day or per hour. What 
is of concern to both is the cost of labor according to 
efliciency units. As we saw in an earlier chapter, well 
paid labor is often cheaper, in the long run, than badly 
paid labor. If we may assume that wages in the shoe 
manufacturing industry were insuflicient, before the hy- 
pothetical increase, to afford adequate nutrition, clothing 
and housing, or though sufficient for these purposes, in- 
adequate to produce the atmosphere of contentment and 
buoyancy in which men do their best work, it is entirely 
possible that a part, or even the whole of the ten per 



WAGES AFFECTED BY LABOR ORGANIZATIONS 219 

cent increase will be compensated for by increased effi- 
ciency. There is not the least doubt that labor could 
make itself ten per cent, or even twenty-five per cent 
more efficient in the average American industry, if it 
found this worth while and set resolutely about it. 

But does organized labor wish to make itself more 
efficient? Or does it not rather cherish the doctrine that 
the less work each man performs, the greater the chance 
that there will be jobs for everybody and hence good 
pay for all? The latter view has, unfortunately, been 
widely accepted by the working class. But the contrary 
view is rapidly gaining adherents. At least one important 
American trade union avows publicly the doctrine that 
the organization should make itself responsible for pro- 
duction standards and do its best to increase output. 
Similar views are generally held by the most influential 
labor leaders in Europe. And if ever we reach a con- 
dition in which every workman must do his best in order 
to hold the esteem of his fellows, we shall enjoy a pro- 
digious increase in production and an adequate basis for 
meeting all the reasonable demands of labor. 

But even as matters stand, with no direct indentifica- 
tion in the laborer's mind between increased efficiency 
and increased wages, it must often be the case that an 
increase in wages pays for itself in the long run through 
better work. Why then does not the employer grant it 
without pressure from the union? Partly because he has 
the bad habit of confusing low wages with cheap labor. 
And chiefly because the cost of higher wages makes it- 
self felt immediately, while the improvement in efficiency 
will not make itself felt for months, for years, or even 
within a generation. Raising the wages of the present 
body of laborers enables them to bring up their children 
better and promises a more efficient people, say, twenty 
or thirty years from now. Is the employer of to-day to 



220 INTRODUCTION TO ECONOMICS 

be blamed if he fails to see why he should pay for this 
future public advantage out of his private pocket? But 
the impartial outsider ought to bear in mind this possible 
advantage when he is passing judgment on the rights and 
wrongs of the labor struggle. 

3. Existing labor organizations fall Jar short of 

the position of power assumed in the pre- 
ceding section. Much of their policy is 
directed toward establishing such a position. 
There is not in America, so far as the writer knows, 
a single branch of industry which is completely organized. 
In some branches the organization members represent 
only a small fraction of the persons working in the in- 
dustry or trade; in other branches the organization may 
make up the majority. Whatever the organization may 
do, some part of every industry will be operated in 
spite of its decrees. Therefore the organization must 
endeavor to keep its demands within the limits of moder- 
ation. A ruthlessly monopolistic policy would open the 
way to the rapid development of such parts of the in- 
dustry as lay beyond the control of the organization. 

The chief objects of labor organization are better 
wages, shorter hours, and pleasant and wholesome con- 
ditions of employment. But as means to these ends the 
organization naturally works to secure the adherence of 
all persons working in the trade it seeks to control and 
strives to keep the trade free from over-crowding, and 
whenever possible, to gain the support of other organized 
bodies of labor in its struggle with the employer. 

4. The typical form of labor organization is the 

trade union, an association of laborers em- 
ployed in the same trade. 
In a trade which has become well established, a natural 
basis for organization is found in the mutual sympathy of 
those whose lives are passed under like conditions. One 



WAGES AFFECTED BY LABOR ORGANIZATIONS 221 

carpenter knows how to evaluate the problems of life and 
work of another carpenter. Even where there is no for- 
mal organization in a trade, we find a tendency among 
the members to work in harmony. They assist one an- 
other in finding work; members of the trade who are 
prosperous contribute to the support of those members 
who fall ill or are otherwise overtaken by misfortune. 
Moreover, the typical workman is reluctant to underbid 
a fellow-workman of the same trade in his dealings with 
an employer. Competition, then, is materially restricted 
even in trades without a formal organization. 

With the appearance of a class of large employers, the 
inchoate organization of labor developed into the formal 
organization which we call the trade union. In its simple 
form, the trade union is an association of all, or of a 
large proportion, of the men exercising a trade in a 
given locality. The association has regular meetings 
where the conditions of employment are discussed, and 
rules are adopted governing the conduct of members. 
Officers are elected for the purpose of systematizing the 
work of the association, and of enforcing its rules. 

It is rarely if ever the case that all persons in the trade 
are members of the union. Some workmen are averse 
to the restrictions upon their personal liberty that union- 
ism represents; some are unable or unwilling to assume 
the financial responsibilities that membership entails; still 
more lack the courage to join in the struggles with the 
employers that every organization must face, sooner or 
later. Where the strife between the workers and the 
employers is not intense, the relations between members 
of the union and non-members may be entirely amicable. 
The non-members work alongside of the members, and 
demand and receive the same wages. Where the union 
laborers are engaged in a conflict with their employers, 
they usually manifest hostility to the non-union men, 



222 INTRODUCTION TO ECONOMICS 

since the latter may accept employment, to the great 
injury of the cause of the union, and in any event fail 
to carry their fair proportion of the burden of the struggle 
though hoping to profit by it. 
5, As a matter of practical policy, a strong trade 
union usually endeavors to induce all men 
exercising a trade to become members of the 
organization. Sometimes union men are 
forbidden to work for employers who employ 
non-union men. This is known as the 
^^ closed shop^^ policy. 
The presence in an industry of a large number of men 
who take no part in the existing labor organization materi- 
ally weakens the position of the organization. The union 
may, therefore, use every means to persuade all persons 
in the trade to become members of the organization. 
If any refuse, and the union possesses the necessary 
strength, it may endeavor to force them to become mem- 
bers by harassing employers who admit the non-union 
men to their shops. This policy is often denounced by 
representatives of the employing class as an unwarranted 
interference in the rights of the non-union men. It is 
further denounced as an attempt to compel the employer 
to assist the union in controlling its membership. Whether 
the closed shop policy is justifiable or not depends en- 
tirely upon the general policy of the union. If it admits 
to membership all men having the necessary qualifi- 
cations for the work to be done, upon payment of reason- 
able membership fees, it is difficult to see how the men 
who are compelled to become members have any real 
grievance. So long as the demands of the union for 
higher wages or shorter hours are moderate, the impartial 
outsider cannot censure the organization for trying to 
make its position as strong as possible. In recent years, 
the closed shop policy has been relegated to a position 



WAGES AFFECTED BY LABOR ORGANIZATIONS 223 

of secondary importance. The closed shop is still the 
ideal of trade unionism, but it is seldom found worth 
fighting for. In some industries a compromise has been 
effected in the ''preferential shop." The employer agrees 
to give the preference to union men, but reserves the 
right to take on non-union men when not enough union 
men are available. 

6. The trade union, whenever possible, places 
limits upon the number of persons admitted 
to the trade. 

If the wages of skilled workmen in any trade rise 
much above the general level, there is likely to be an 
influx of laborers from other employments, whose pres- 
ence in the trade has the effect of reducing wages. In 
some cases the free admission to a trade of all who de- 
sire to exercise it would reduce wages below the normal 
level. In tht building trades, for example, wages appear 
to be higher than they really are. The members of these 
trades receive high wages for the time they are employed 
but employment is very uncertain. In the greater part 
of the country, the winter represents a slack season in 
which very few members of the building trades find 
steady employment. This irregularity of employment 
does not receive due consideration from young men who 
are about to choose a trade; hence unrestricted admission 
to the trade might easily depress annual earnings below 
the normal level. 

Restrictions upon entrance to a trade may take the 
form of apprenticeship regulations that are sufficiently 
onerous to reduce the number of beginners. Formerly, 
a seven-year apprenticeship was required in many trades. 
During the period of apprenticeship, the worker received 
no wages, and this in itself narrowly limited the num- 
ber of persons who could afford to enter a trade. In 
some trades, an apprenticeship of three or four years 



2 24 • INTRODUCTION TO ECONOMICS 

is still required. Another method of limiting the number 
of apprentices is to prescribe the proportion of apprentices 
to trained workmen that an employer may have in his 
shop. It is easy to see that through such restrictions 
upon apprenticeship an artificial scarcity of labor in any 
one trade may be created, and wages may be kept at 
an abnormally high level. Those who are prevented from 
exercising the trade are forced into occupations where 
such limitations upon the labor supply are impracticable, 
thus depressing wages in those occupations. Consumers 
of the products of industries in which labor holds a monop- 
olistic position are forced to pay abnormally high prices. 
There are, however, very few trades strong enough to 
raise wages much above the level that the degree of skill 
necessary would, in the long run, command, even if 
admission to the trade were perfectly free. 

7. The position of a trade union is greatly 
strengthened by the accumulation of funds for 
the relief of members in time of sickness or 
unemployment. 
The mere wage earner is at all times exposed to the 
danger of want as a consequence of accident, sickness, or 
prolonged unemployment. What he can save individually 
is seldom sufficient to carry him through a long period of 
time in which he earns nothing. The trade union, by 
collecting contributions from those members who are 
receiving wages and by distributing the money among 
those who are in need, greatly reduces the uncertainties 
of the laborer's lot. A plan of mutual insurance binds to 
the union many who would otherwise hold themselves 
aloof from it. Moreover, it keeps those who are out of 
work from offering their services to the employer at a 
reduced rate of pay, and thus prevents the demoraliza- 
tion of the labor market. 
But the most important object to be attained through 



WAGES AFFECTED BY LABOR ORGANIZATIONS 225 

the accumulation of funds is the strengthening of the union 
in a dispute with the employer. With a large fund, a 
union may be able to keep its members from accepting 
work through a period of several months — long enough to 
inflict serious losses upon a recalcitrant employer. A 
union without funds may be easily starved into sub- 
mission to the employer's conditions. 

8. The position of a union is strengthened by 
an alliance with unions in related trades, 
or even in unrelated trades. 

Such trades as the carpenters, the masons, the plas- 
terers, and other building trades, have much to gain 
through working in harmony. At one time the carpenters 
may have a strong organization, and the masons a weak 
one; at another time the reverse may be true. On one 
job a small number of masons may be needed, and a large 
number of carpenters. In such cases, the union masons 
could perhaps be replaced by the non-union masons that 
are to be found in every city, while it would be more 
difficult to secure a sufficient number of non-union car- 
penters. The building contractor must have men of each 
trade, and if he engages in a dispute with the union 
whose position is weak, pressure can be brought upon 
him by the union whos e position is strong. A harmonious 
organization of allied trades can thus always place its 
strongest forces at the front. 

An advantage of a different nature arises from an alliance 
of unions in unrelated trades. The cigar makers' union 
can bring no direct pressure to bear upon the employers 
of garment workers; but when garment workers are 
thrown out of employment by a strike, the cigar makers 
can contribute to their support. At another time contribu- 
tions from the garment workers may assist the cigar 
makers in securing better terms from their employers. 



226 INTRODUCTION TO ECONOMICS 

9. A trade union in one locality is strengthened 
by an alliance with unions in other local- 
ities. 

In a period of such easy communication as the present, 
a purely local labor organization can accomplish little. 
In a dispute between a labor organization and an em- 
ployer, the latter can quickly import laborers from other 
localities to replace his former employees. Apprentice- 
ship regulations in one locality are enforced in vain, 
if in other localities .the labor market is overstocked 
through unrestricted apprenticeship. 

Even when no importation of labor takes place, the 
union confined to a single locality finds difficulty in 
raising wages or reducing working time. Such measures 
usually represent cost to the employer, and if the pro- 
duct is one which must enter into competition with like 
products from other localities, the concessions that the 
employer can make to his employees are narrowly lim- 
ited. If the textile workers of Fall River demand higher 
wages, the employers may be unable to grant the demand 
without raising the price of cloth to such an extent as 
to encourage the competition of other textile manu- 
facturing districts. 

The importance of a central organization appears 
nowhere more clearly than in the case of industries in 
which extensive consolidations have been formed. If the 
laborers in one steel plant demand higher wages, the 
plant can be closed down, and the orders executed in 
other works where there is no trouble with the laborers. 
The employer loses practically nothing, and the laborers 
are in the end compelled to return to work on such terms 
as the employer may dictate. 

In any event an organization covering a wide range of 
territory affords an excellent means of raising funds for 
local organizations in time of labor disputes. When the 



WAGES AFFECTED BY LABOR ORGANIZATIONS 227 

cigar makers of New York are on strike, the cigar makers 
in Philadelphia, Boston, Chicago, and other cities raise 
funds for their support. 

The foregoing considerations have led to the forma- 
tion of national or international unions in almost every 
important trade. In government these organizations are 
sometimes loose federations, sometimes strongly cen- 
tralized bodies. In the centralized union the local union 
is required to obtain the consent of the national union 
before inaugurating a strike; the national officers can 
call a strike in any locality, even if the members of the 
local organization are content with their condition. The 
essence of the power of the national union is its control 
over the funds that are accumulated for emergencies. 
A local union which goes on strike without proper author- 
ization forfeits its claim to strike benefits from the na- 
tional organization; a local union which refuses to strike 
when ordered to do so is suspended or expelled from the 
national union, and is subjected to more or less severe 
discipline before it is reinstated in the organization. 

10. National organizations have much to gain 
through a central organization covering the 
whole field of industry. 

In the United States most of the national unions are 
associated in a great central organization known as the 
American Federation of Labor. This organization fur- 
nishes a means by which the support of the entire trade- 
union world may be given to unions engaged in an ex- 
tended contest with their employers. The American Fed- 
eration pretends to no direct control over its constituent 
members, but unions about to engage in a labor dispute 
naturally consult with the officers of the Federation and 
seek the cooperation of that body. The American Fed- 
eration collects information relating to the entire field of 
labor and assists in organizing unions in new fields. 



228 INTRODUCTION TO ECONOMICS 

When disputes arise between different labor organizations, 
the American Federation officials act as arbitrators; when 
factional strife causes the disruption of a union, the 
officers of the Federation are active in effecting a re- 
organization. 

11. The principal weapon in the hands of or- 
ganized labor is the strike. A strike is a 
concerted suspension of work for the purpose 
of enforcing some demand upon the em- 
ployer. 
Sometimes the mere fact that demands are presented 
to the employer by an organization including his entire 
working force leads to concessions that would never be 
made to isolated employees. In many cases, however, 
the employer refuses to consider the demands of his 
employees, and a strike is called. It is possible that the 
employer would be unable to grant the demands even 
if he desired to do so. In perhaps a majority of instances 
the demands could be granted in part or wholly without 
serious loss to the employer. At all events the laborers 
believe this, and in suspending work they feel that they 
are merely stopping operations long enough to reach a 
satisfactory adjustment of the matters in dispute. Some- 
times the employer also takes the sariie view of the mat- 
ter and makes no attempt to replace his striking work- 
men. 

If the employer feels that the demands of the men are 
wholly unreasonable, or that even if they are reasonable 
the union is not strong enough to enforce them, he is 
likely to attempt to fill the places left vacant with labor- 
ers who are not controlled by the organization of the 
strikers. This the latter must prevent, if they are to 
have any chance of winning. If there is nowhere to be 
found an adequate number of laborers willing to work 
as strike breakers, the strikers may be content to allow 



WAGES AFFECTED BY LABOR ORGANIZATIONS 229 

the employer to experiment with inefficient men. If the 
efforts of the employer to secure laborers appear to be 
successful, the strikers endeavor to persuade the strike- 
breaking laborers to join in the suspension of work. Pick- 
ets are stationed at the entrance to the works, to inform 
all men coming to their tasks that a strike is in progress. 
If the strike breakers do not yield to peaceable persuasion 
the pickets often resort to intimidation. Where the con- 
test becomes very bitter, the strikers sometimes employ 
violence to frighten the strike breakers from their work. 
The employment of violence is discountenanced by the 
leaders of the strike; nevertheless, a great strike has sel- 
dom been entirely free from instances of injury inflicted 
upon strike breakers. While the right of workingmen to 
strike is recognized under American law — except in Kan- 
sas — the tradition of violence which has gathered around 
the strike has led to the employment of the legal device 
of the injunction, often to the serious disadvantage of the 
strikers. They may be enjoined from picketing, from 
using even peaceful persuasion to dissuade other workers 
from taking their places. Thus the court often, in effect, 
throws its weight on the side of the employer. 
12. A second possible weapon of organized labor is 
the boycott. A boycott is an association having 
for its purpose the destruction of the business 
of an employer through pressure brought to 
hear, directly or indirectly, upon those who 
have business relations with him. 
When men are on strike, they naturally refrain from 
purchasing the products of their former employer, and per- 
suade their friends to follow the same course of action. 
This is a simple form of the boycott; it may be fairly ef- 
fective when the product is destined for local consumption 
by the working class. An employing baker, for example, 
may be brought to terms in this way. Where the product 



230 INTRODUCTION TO ECONOMICS 

is placed upon a general market the boycott takes a more 
complex form. The whole trade-union world may be 
warned not to buy the products of the offending employer. 
Such boycotts are illegal, under the present interpretation 
of American law and can be employed only by indirection. 
Their effectiveness is therefore slight. 

Sometimes the boycott takes a very roundabout course. 
A merchant is boycotted for handling the products of an 
"unfair" shop; laborers are boycotted for buying goods 
from such a merchant; men who employ these laborers 
are boycotted, and so on. These roundabout boycotts are 
not very frequent nor very important. They are of doubt- 
ful value to the laborers' cause, as they inflict more hard- 
ship upon innocent parties than upon the persons against 
whom they are ultimately directed. Since such boycotts 
are illegal, their employment is pretty certain to bring the 
courts into the field on the side of the employer. 

13. Strikes and boycotts may he carried on by work- 
men who have no formal organization. 

We have spoken of strikes and boycotts as the weapons 
of organized labor. As a fact, however, a great many 
strikes take place in trades that are not orgariized in unions. 
For the purpose of carrying on a strike a temporary or- 
ganization is effected which may be abandoned when the 
strike is won or lost. Boycotts, under one name or another, 
have often been employed by unorganized laborers. 

It is not certain whether the formation of trade unions 
leads to an increase or to a reduction in the number of 
strikes. It is undoubtedly true that a permanent organ- 
ization results in a reduction in the number of strikes hav- 
ing no adequate cause. A trade union develops responsible 
leaders who do everything in their power to prevent a strike 
when the chances of winning are small. 



WAGES AFFECTED BY LABOR ORGANIZATIONS 231 

14. In many trades where powerful organizations 
have been established, the terms of employment 
are fixed, not by bargaining between the em- 
ployer and the individual workmen, but by 
agreements between representatives of the 
laborers, on the one hand, and representatives 
of the employers, on the other. This plan of 
fixing the terms of employment is known as 
collective bargaining. 
In the bituminous coal district of the North Central 
states representatives of the miners and representatives of 
the mine operators meet annually to determine the rate 
of wages to be paid. In these meetings all the circumstances 
of the industry are fully discussed, — the prices that the 
product is likely to command, the cost of placing it on the 
market, the cost of living of the workmen, the wages paid 
in other districts, etc. As a result of the discussion each 
side gains a fairly clear understanding of the position of 
the other. It becomes impossible for the laborers to insist 
upon terms that the employers cannot possibly grant, as 
not infrequently happens where no machinery for collective 
bargaining has been established. Differences of opinion 
as to what constitutes a fair wage naturally arise; but 
through full discussion and mutual concessions these dif- 
ferences are prevented from causing a rupture of negotia- 
tions. Since the adoption of the plan of joint conferences 
agreements have always been reached, and have in most 
cases been loyally observed by both employers and em- 
ployed. 

In a number of other American industries similar methods 
of collective bargaining are employed, and in England, 
where trade unionism is more powerful than in any other 
country,, all the great industries establish the conditions of 
employment by collective bargaining. 
It is clear that in a complex modern industry, only the 



232 INTRODUCTION TO ECONOMICS 

more general conditions of employment can be fixed by 
such agreements. Minor disputes will constantly arise re- 
lating to the interpretation of the general agreement. Pro- 
vision is usually made for the settlement of such disputes 
by a committee representing both the workmen and the 
employers. Where such a committee is unable to reach 
a decision, resort is had to the services of an impartial 
outsider who acts as arbitrator. 

In some industries there is a general understanding that 
if no agreement as to the renewal of the contract can be 
reached, the matters in dispute shall be settled by arbitra- 
tion. Such arbitration, however, is not always successful, 
since either the laborers or the employers may prefer to 
submit to a trial of strength rather than accept the onerous 
conditions of the arbitrators' award. 

15. When a strike has been in progress for a long 
time, and both parties to the dispute are thor- 
oughly wearied with it, though either is unwill- 
ing to surrender its claims, resort may be had 
to arbitration. 

In perhaps a majority of the important strikes of recent 
years each party to the controversy has taken a position 
which is not wholly defensible. The demands of the men 
are excessive, and the terms that the employer insists upon 
are unnecessarily onerous to the men. Negotiations are 
broken off and a strike follows, to the serious injury of both 
parties. As the burdens of the struggle grow heavier, each 
party sees that its original position was untenable, but 
shrinks from making concessions, fearing that to do so 
would be to confess itself worsted in the struggle. The only 
way in which the difficulty can be settled without loss of 
prestige to either party is through submission of the mat- 
ters in dispute to arbitrators mutually agreed upon. Both 
parties bind themselves to accept the award of the arbi- 
trators in good faith, and instances are rare in wjiich this 



WAGES AFFECTED BY LABOR ORGANIZATIONS 233 

agreement is disregarded. The award of the arbitrators 
is seldom anything more than a balancing of concessions; 
it usually satisfies neither party, but is accepted as a lesser 
evil than a continuance of the struggle. 

16. Arbitration may be forced upon the parties to 
an industrial dispute by the pressure of public 
opinion. 

While the persons most seriously injured by the continu- 
ance of an industrial dispute are the laborers and employ- 
ers directly involved, no important strike can be conducted 
without injury to the public. A strike of railway laborers 
almost inevitably injures innocent parties more than it in- 
jures the railway companies against which the strike is 
directed. The blocking of the street railway system of a 
great city through a strike inflicts immeasurable injury 
upon the general public. A strike of coal miners neces- 
sarily produces great distress among the poorer classes who 
are seldom in a position to keep a reserve of fuel; the re- 
sulting high price of coal causes the closing down of many 
shops and factories with consequent losses in wages and 
profits. In almost every great strike instances of violence 
are frequent, and the charges upon the public for maintain- 
ing the peace are greatly increased. 

Accordingly there are the best reasons why persons rep- 
resenting the interests of the pubHc should undertake the 
task of bringing about a reconcihation between the em- 
ployers and their striking employees. In some cases those 
who undertake this task limit themselves to inducing the 
disputants to meet in conference to discuss the matters 
at issue. This may of itself lead to a settlement of the 
dispute. Such intervention is known a§. conciliation. In 
other cases an attempt is made to force the disputants 
to submit to arbitration. Often the movement to force 
arbitration is initiated by the party to the dispute whose 
sufferings are greatest or whose prospects of victory are 
least promising. 



234 INTRODUCTION TO ECONOMICS 

17. // would be a great gain to society if industrial 
disputes could be submitted to arbitration as 
soon as they arise, instead of toward the close 
of a long contest. 

No argument is necessary to show that a strike is a waste- 
ful way of estabhshing the conditions of employment. 
Since a settlement is likely to be effected by arbitration, 
why is a long and expensive struggle necessary? Why do 
not the disputants resort to arbitration at the outset? 

In most cases an industrial dispute is based upon irrecon- 
cilable differences of opinion. The employer offers what 
he considers as good terms as he needs to give; he believes 
that the laborers will be compelled to accept these terms 
in the end. The laborer demands what he regards as the 
lowest wages that he can be compelled to accept in the 
circumstances; he believes that the employer will in the 
end concede his demands. Arbitration would almost cer- 
tainly result in terms that each party to the controversy 
would regard as unfair to itself. Consequently each party 
prefers to resort to a trial of strength. After the struggle 
has continued for some time, and each party has gained an 
insight into the real strength of the other, the necessity of 
mutual concession becomes apparent to every one con- 
cerned. Terms that would, at the outset, have been spurned 
by both parties can be accepted, though perhaps reluc- 
tantly, by both the employer and the employee. 

It is accordingly clear why a plan of purely voluntary 
arbitration is ineffective as a means for preventing strikes. 
Many of our states have created commissions or boards of 
arbitration with authority to settle industrial disputes upon 
the application of both contestants. The services of these 
officials are not often requested. 

In New Zealand employers and organized laborers are 
required by law to settle their disputes without recourse 
to strikes. The colony is divided into districts in each of 



WAGES AFFECTED BY LABOR ORGANIZATIONS 235 

which a board of conciliation exists which is authorized to 
inquire into all labor disputes with the purpose of effecting 
a settlement by mutual agreement. If the parties to the 
dispute cannot be brought to an agreement, the dispute is 
referred to the court of arbitration, which hears both sides 
and renders a decision which is binding. Under the New 
Zealand system the strike has been eliminated. An anal- 
ogous plan has been introduced in the state of Kansas, 
where a Court of Industrial Relations has been created to 
hear and determine disputes between employers and em- 
ployees. No strike in an industry vital to the pubhc is 
permitted. Whether the plan will prove successful in the 
end even in a state so slightly industrialized as Kansas, and 
whether it would work successfully in more highly indus- 
trialized states, remain open questions. 

18. The organization of labor modifies the operation 
of the competitive law of wages, hut does not 
subvert that law. 

It has often been noted that in times of prosperity labor 
organizations are usually able to force a rise in wages; in 
times of depression such organizations are unable to check 
a decline in wages. In times of prosperity the trend of 
wages, both of organized and of unorganized labor, is up- 
ward; in times of depression it is downward. In economic 
terms prosperity means an increase in the value product 
of labor, and the laws of competition compel the employers 
to raise wages accordingly. Depression means a reduc- 
tion in the value product of labor, and hence results in 
a reduction in wages. 

But the competition of employers is never very acute, 
and for a long time they may fail to raise wages, although 
the general circumstances of industry justify higher wages. 
It is only as increased profits lead to an expansion of in- 
dustrial operations and an increased demand for labor that 
the competition of employers takes the form of an increase 



236 INTRODUCTION TO ECONOMICS 

in wages. Labor organization may force an advance in 
wages long before the competition of employers would lead 
to the same result. By virtue of organization the laborer 
shares more promptly, and probably more Hberally in the 
increased productivity of industry than he would if he 
reHed upon his individual bargaining power. 

While we must grant to labor organizations an impor- 
tant influence in maintaining a high level of wages, we 
must not forget that this influence may easily be over- 
estimated. Wages are higher in America than in England, 
not because our labor organizations are stronger than those 
of England, — for the reverse is true, — but because labor 
is more productive in this country than in England. Wages 
will remain at a high level in this country so long as the 
high productivity of labor is maintained; and no form of 
organization can long maintain wages in the face of decHn- 
ing productivity. 

19. Summary. 

While the forces of productivity and competition deter- 
mine broadly what wages may be paid, there are limits 
within which labor organizations can work effectively to 
improve the condition of their members. Such improve- 
ment may take place at the expense of other participants 
in the process of production, or of the consumer, or it may 
result in an increased efficiency that provides the means 
for satisfying the requirements of labor. 

The trade union is an association composed of workmen 
employed in the same trade. When such an organization 
is formed an attempt is made to induce all the men practic- 
ing the trade to become members. After the organization 
gains practical control of a trade, it may endeavor to limit 
the number of men admitted to the trade, in order to main- 
tain a high level of wages. 

A trade union's position is greatly strengthened if it 
undertakes the relief of its members in time of sickness, 



WAGES AFFECTED BY LABOR ORGANIZATIONS 237 

accident, or unemployment. The principal function of 
trade union accumulations is the maintenance of the mem- 
bers of the union in time of strike. Each local union, fur- 
ther, is greatly strengthened by alhances with other unions 
in the same locality or in other parts of the country. 

The chief weapons of the trade union are the strike and 
the boycott. Where trade unions are strong they are often 
able to make satisfactory terms with their employers 
without resort to the strike. In many cases the terms of 
employment are established by agreement between the em- 
ployers on the one hand and representatives of the trade 
union on the other. 

Disputes between employers and workmen are some- 
times settled by arbitration, without resort to a strike. In 
cases of prolonged struggles between employers and em- 
ployees, public opinion may compel a submission of the 
matters in dispute to arbitration. In New Zealand all 
disputes between employers and organized laborers must 
be settled by arbitration. In Kansas disputes in industries 
supplying a vital public need are subject to the jurisdiction 
of the Court of Industrial Relations. 



CHAPTER XIII 
THE PRODUCTIVITY OF CAPITAL 

1. The term ^^ capital goods ^^ may be employed to 
designate objects of wealth that yield an income. ' 

Men who are engaged in business commonly divide their 
material possessions into two classes; those that are held 
for the money income they yield, and those that are held 
for the immediate satisfaction they afford. The objects 
composing a merchant's stock in trade, his buildings and 
fixtures, belong to the former class. The merchant's watch, 
the clothes he wears, the horse he rides for recreation, be- 
long to the latter class. The former class we shall call 
*' capital goods"; the latter, ''consumer's goods." When a 
man buys capital goods, he is commonly said to ''invest 
money." When he buys consumer's goods, he is said to 
"spend money." 

The distinction, it is true, is not so easily drawn as 
might at first appear. Is a man's house to be classed with 
his capital goods? The income that it affords is primarily 
one of satisfaction, like that afforded by a watch or a saddle 
horse. The possession of a house saves the payment of 
rent, and to this extent adds to one's disposable income. 

Reflection will show, however, that goods yielding an 
income of direct satisfaction are normally distinguished by 
their owners from goods yielding a money return. The 
standards governing purchases of goods for business pur- 
poses are adequacy and sureness of return; the standard 
governing purchases of goods serving personal uses is what 
one can afford. A home is seldom strictly a "business prop- 
osition," and for this reason may usually be excluded from 

238 



THE PRODUCTIVITY OF CAPITAL 239 

the rank of capital goods. And the same thing is true of 
other goods yielding an income, not of money, but of 
satisfaction. 

2. The permanent fund of productive wealth which 
capital goods represent is known as capital. 

The great majority of capital goods are perishable in 
their nature. The capital goods of a merchant, so far as 
they consist of merchandise, are destined in a very short 
time to pass into the hands of the merchant's customers, 
where they cease to be capital goods. So far as they consist 
of buildings and fixtures, they may endure a generation 
or more; but in the end the buildings depreciate and the 
the fixtures become antiquated. It would be next to impos- 
sible to find a business establishment which has precisely 
the same capital goods it had a year ago. It is an easy 
matter to find an establishment which. is said to have the 
same capital that it had a year ago. A merchant starts in 
business to-day with a capital of $100,000 invested in 
building and stock. At the end of a year we ask him what 
his capital then is. Very likely it will stiU be $100,000. 
Now, is this the same capital, or is it a new one? The 
merchant certainly will say that it is the same capital — • 
unless, of course, he has lost, in the course of the year, his 
original capital and has replaced it from some new source. 
But how can the capital be the same after the lapse of a 
year? Nearly all the things that figured in the first inven- 
tory except the building, have been replaced, in the second 
inventory, by objects which may be of a quite different 
character. In the first inventory, perhaps, cheap grades 
of goods preponderate; in the second these may be largely 
replaced by higher grades. However this may be, there 
can be no denying that the goods have changed, yet the 
merchant says that the capital is the same. 

Perhaps we are making ourselves unnecessary difficulties 
in our endeavor to arrive at the merchant's meaning when 



240 INTRODUCTION TO ECONOMICS 

he says that his capital remains the same even after most 
of the things originally composing it have left his posses- 
sion. Possibly he means simply that he has as large a capi- 
tal at one time as at another. Two things that are equal 
in magnitude are of course not the same thing, but we often 
speak of them as if they were. 

Yet if we reflect upon it, this does not appear to be what 
the business man means. Suppose that fire or flood had 
destroyed his store and stock, and that a rich relative, to 
set him on his feet again, had given him $100,000 to re- 
place them. The merchant would not say that he was 
continuing in business with the same capital, although in 
magnitude it would be the same. Clearly, a business man 
thinks of his capital as something that is capable of remain- 
ing permanently the same although the goods that compose 
it are constantly changing. The popular conception of 
capital is a fund of productive wealth, which has the power 
of self-perpetuation. This conception we may accept as one 
of the simplest that have been proposed. 

3. The permanence of capital depends upon the 
economic power of capital goods to replace their 
value either through sale or through assistance 
rendered in production. 

An enterpriser possessing $100,000 in cash proposes to 
establish a clothing store. The first thing he must do is to 
find a place where, he has reason to believe, the goods in 
which he proposes to deal will sell at a higher price than 
that which he must pay for them. This, of course, is com- 
paratively easy to do. Goods, as they come from the fac- 
tory, may in a physical sense be ready for use; economi- 
cally, however, much remains to be done before they can 
be placed where they will fulfil their ultimate purpose — 
the direct satisfaction of human wants. They must be con- 
veyed to places where they are accessible to the consumer ; 
they must be so arranged that inspection is easy. Expert 



THE PRODUCTIVITY OF CAPITAL 241 

salesmen must be at hand to point out their good quaHties 
and explain away their bad ones. This means that a con- 
siderable addition to the value of goods may be made after 
they have left the factory; and this addition, properly 
speaking, is the product of the mercantile establishment. 

Each item of the stock normally sells at a price which 
will at least replace that item with one of equal value, to- 
gether with a surplus which will cover the cost of labor 
employed in handling it, and which will also make some con- 
tribution to the expense of keeping up the building. Any 
item which does not do this not only yields nothing toward 
interest on the capital invested in stock and building; it 
is carried at a loss; and a business man who should con- 
tinue to carry such items would see his capital diminish, 
and perhaps ultimately disappear. Some parts of the stock 
may afford a far larger surplus, and the aggregate income 
of the establishment may be much more than enough to 
keep stock and store intact, after paying for all human 
services directly employed. The nature of this excess of 
income above outlay we shall consider at a later point. 
For the present we are concerned primarily with the fact 
that the first demand upon the business is that each item 
shall maintain itself — i.e., through sale, reproduce itself 
together with auxiliary costs connected with it. 

It must now be clear how it is that a fund of capital 
persists. Each capital good, before it is sold or worn out, 
produces a sum of value that enables the owner of the good 
to purchase or make another good of the same character, 
which in its turn possesses the power of replacing itself by 
a successor of equal value. The capital goods of this year 
are, therefore, not merely the successors in time of those of 
last year, now mostly destroyed; they are, economically, 
the offspring of the capital goods of the earlier period, and 
they have the same power of replacing themselves with 
other goods having the power of self -replacement. 



242 INTRODUCTION TO ECONOMICS 

It is, of course, to be understood that this self-replace- 
ment is neither automatic nor inevitable. We may say that 
under certain conditions a particular capital good will add 
something to the total product of an industry, but not 
enough to keep itself in repair and replace itself when worn 
out. Under other conditions a capital good will just do 
this; under still other conditions a capital good will add 
to the product of an establishment not only enough for its 
own repair and replacement, but a surplus besides. Ex- 
perience has taught enterprisers how to avoid the employ- 
ment of capital goods that do not maintain themselves, and 
of those that do nothing more than this. Mistakes are of 
course sometimes made, but not so frequently as to invali- 
date the statement that capital goods, as a rule, reproduce 
themselves economically through the values which they 
create. Intelligent action on the part of the owner of such 
goods is essential to the truth of this proposition; but such 
action may generally be taken for granted. 

4. What is capital to the individual may not be pro- 
ductive wealth from the point of view of society. 

A government may sell its bonds in order to raise funds 
to carry on a profitless war. The money raised is spent 
on powder and other munitions of war, which are soon de- 
stroyed. The wealth furnished by the purchasers of the 
bonds has simply been wasted, and cannot contribute to 
the payment of interest on the bonds or of the principal 
when it falls due. Interest and principal are, indeed, paid, 
but from the proceeds of taxation. The bondholder re- 
gards his bonds as capital; they are wealth that yields an 
income, as he views the matter. But we can easily see 
that it is not the bonds that produce the income; it is the 
labor and wealth employed in production that do this. If 
all the bonds were destroyed, the aggregate social income 
would be not in the least reduced. 

Capital of this kind may be called '^ purely acquisitive 



THE PRODUCTIVITY OF CAPITAL 243 

capital." It enables its holder to acquire an income ; it does 
not produce an income. Capital which actually participates 
in production may be called ''productive capital." The 
laws which we shall discuss in this chapter relate only to 
productive capital. 

5. Productive capital may he embodied in goods that 

are the product of industry, or in goods that are 

the free gift of nature. 
A generation ago practically all economists restricted 
the term "capital" to productive wealth that has been pro- 
duced by industry, such as machines, stocks of materials, 
etc. Productive wealth the origin of which cannot be 
traced to man's industry was usually classified under the 
heading ''natural agents," or simply under "land," since 
land is by far the most important good in this class. This 
terminology is still widely used by economists. In every- 
day language men speak of investing capital in land, as of 
investing capital in buildings or machinery. This usage 
will be followed in this book; wherever it is necessary to 
distinguish between the two classes of productive wealth, 
we shall call the one artificial capital, the other natural 
capital. 

6. Artificial capital originates in saving. 

It may at first appear that capital comes into existence 
whenever a productive instrument is created. Reflection 
shows, however, that this cannot be true, for a new capital 
good often merely replaces a capital good worn out in the 
process of production, and may be said to embody the same 
capital. 

When a man employs, in producing a tool or a stock of 
the materials of production, time which he would otherwise 
have used to procure for himself the means of immediate 
enjoyment, he is creating capital. These capital goods are 
not merely replacing capital goods previously existing; 
they are a net addition to the stock of productive wealth 



244 INTRODUCTION TO ECONOMICS 

at the command of society, which, like other capital goods, 
will for the future maintain themselves. When a man 
uses, to employ workmen in the production of capital goods, 
a part of his income which he would otherwise have spent 
for consumer's goods, he is causing new capital to be 
created; or, we may say, he is indirectly creating capital. 
When he uses part of his income to buy capital goods that 
are already in existence, he is creating new capital by a 
still more indirect process. Thus if a man buys a threshing 
machine out of his savings, he places in the hands of the 
manufacturing company purchasing power with which the 
company can hire men to make another machine. The 
process of creating new capital may take a yet more round- 
about course. The man who saves may invest his savings 
in a share of railway stock — which is nothing more than 
an evidence of ownership of capital goods already existing. 
The man who sells the share of stock may use the proceeds 
to buy a share in a manufacturing company. Here again 
it is evident that nothing new is created. The seller of the 
manufacturing stock may, however, use the money to buy 
a share in a new manufacturing company, and this com- 
pany may employ the proceeds to hire men to produce new 
capital goods for use in its business. Evidently it is the man 
who saved the money in the first instance who is the true 
creator of the capital thus added to the stock of society. 

Under present conditions the process of creating capital 
is usually indirect. One man saves and other men produce 
the concrete capital goods in which the savings are invested. 
Of course it sometimes happens that such a complicated 
process fails to attain its proper end. One man may save 
$ioo and buy a share of stock from another man, who uses 
the proceeds to meet his current expenses. In this case no 
new capital is created. What has happened is that a part 
of the existing fund of capital has changed hands. But 
normally men avoid trenching upon their capital; accord- 



THE PRODUCTIVITY OF CAPITAL 245 

ingly, we are justified in regarding each act of saving as the 
creation of new capital. 

Just as it is improper to regard the creation of a capital 
good as in itself a creation of capital, so it is improper to 
regard the destruction of a capital good through ordinary 
use as the destruction of capital. For during its lifetime a 
capital good produces, as we have seen, a replacement fund. 
After the capital good has been destroyed, the capital exists 
under another form — as money or as other productive 
goods. 

7. Natural capital increases with the development of 

society. 
Until the frontiersmen crossed the Appalachian Moun- 
tains, the land of the Mississippi Valley, with the timber 
upon it and the coal and other minerals beneath its surface, 
was scarcely to be classed as wealth at all. At best, it was 
potential wealth, not actual wealth. The settlement of the 
country and the development of means of communication 
transformed this potential wealth into an immense fund of 
productive wealth, or capital. Every increase in popula- 
tion, every improvement in methods of agricultural produc- 
tion, increases the importance, and with it the value, of the 
natural resources of a country. Measuring the capital rep- 
resented by these natural resources in terms of value, we 
see that it is constantly growing with the progress of 
society. The introduction of durum wheat raised the capi- 
tal value of lands in part of the arid belt from practically 
nothing to $10 an acre or more. New processes of steel 
manufacture have endowed iron ore deposits originally 
worth very little with the character of highly productive 
capital. 

8. The productivity of a capital good can he ascer- 

tained only through experimentation. 
In order that a man may conduct his business success- 
fully, he must be able to form a fairly accurate estimate 



246 INTRODUCTION TO ECONOMICS 

of the productivity of each class of capital goods which he 
uses. In the case of some classes of capital goods produc- 
tivity is easily determined. Thus if one wishes to know 
how much a ton of fertilizer will produce^ he has only to 
apply it to one of two equally productive acres of ground. 
The difference in the product of the two acres, less the 
cost of labor employed in applying the fertilizer, is a fair 
test of the productivity of a ton of fertilizer. We may 
term this the gross product of the capital good. After de- 
ducting from this product a sum equal to the cost of the 
fertiHzer, whatever remains is the net product of the capital 
good. 

Some capital goods, however, do not readily admit of 
any such process of experimentation. Thus it might be 
difficult to determine the productivity of a field, apart 
from that of the seed, fertilizer, machinery, and labor em- 
ployed in connection with it. Of course one acre might be 
left untilled, and all the labor and auxiliary capital might 
be employed on the rest of the field. The total product 
would be less than it would have been had all the field 
been tilled ; and this diminution in product would indicate 
roughly the productivity of an acre of ground. This method 
would be clumsy and expensive; it is, moreover, unnec- 
essary, since the productivity of labor and of auxiliary 
capital employed upon the land may be determined, for 
the most part, by the method already illustrated. Hence 
we may arrive at the gross product of the field by subtract- 
ing from the total product of the farm the values produced 
by the labor and the auxiHary capital. By subtracting from 
the gross product of the land a sum of value sufficient to 
replace the elements of fertility destroyed in the course of 
the year, we arrive at the net product of the land. 



THE PRODUCTIVITY OF CAPITAL 247 

9. The net product of capital goods is commonly 

known as the product of capital. 

Capital goods obviously must vary widely in their gross 
product. Some must be replaced daily, some yearly, 
some at the expiration of a decade or more; a few classes, 
like land, are practically permanent. Until full replace- 
ment of goods used up has been made, a fund of pro- 
ductive wealth, or capital, cannot be said to be produc- 
tive. A manufacturer who finds that the receipts from 
a year's business are just sufficient to maintain intact his 
building, machinery, stock of material, and fuel, cannot say 
that his capital has added anything to his income. Capital 
which produces nothing is obviously not worth having; 
and the mere fact that men make sacrifices to possess 
themselves of capital shows that, as a rule, capital may 
be expected to yield an income. 

When a man is considering whether he shall invest his 
capital in one kind of capital goods or in another, he may 
usually take the fact of self-replacement of goods for 
granted. The net productivity of capital goods, or, to 
use a simpler term, the product of capital, is the deter- 
mining factor in his calculations. 

10. The productivity of capital invested in any 

one class of goods is measured by the addi- 
tion made to product by the last or mar- 
ginal unit of capital thus invested. Other 
things equal, the productivity of capital in 
any one form shrinks with increase of capi- 
tal in that form. 
Let us suppose that a farmer possesses ten fields, vary- 
ing in natural fertility from a very high degree to a 
very low degree. And let us assume that $1000 worth 
of capital in the form of machinery, live stock, etc., or 
auxiliary capital, is necessary for the tillage of any one of 
the ten fields. 



248 INTRODUCTION TO ECONOMICS 

If the farmer has control over only $1000 worth of 
auxiliary capital, he will of course place it upon the best 
field. If from the gross product of that field he deducts 
the cost of labor employed in connection with it, together 
with a sum sufficient to cover the cost of upkeep of 
land and auxiliary capital, he arrives at the net product 
of his agricultural capital — that is, of his investment in 
both field and auxiliary capital. How much is due to 
the bare land, how much to the auxiliary capital? This 
it would be difficult to say, as neither would have pro- 
duced anything without the other. 

Now let us suppose that the farmer gets possession of 
another $1000 to invest in auxiliary capital. He may now 
till the field which is least inferior to the first one culti- 
vated. The joint product of this field and of the $1000 
of capital will be less than that of the first field because 
of the difference in natural fertility. Shall we say that 
$1000 is more productive on one field than on the other? 
The two units of capital are just alike; the two fields 
are unlike. So it would seem to be more reasonable to 
assign the difference in productivity to the fields, not to 
the auxiliary capital. And this is what a practical man 
would do. If the first field produces $1000 and the 
second $900, he would say that at least $100 of the prod- 
uct of the first is the product of the land, apart from that 
of the auxiliary capital. 

Is the $900 produced on the second field the product 
of the auxiliary capital alone? In a physical sense, cer- 
tainly not; in an economic sense it is. This sum is what 
the additional $1000 worth of auxiliary capital adds to 
the farmer's income; $900 is what he would lose if he 
were deprived of either of his two units of capital. 

With another $1000 the farmer is enabled to till a 
third field, which is somewhat less fertile than the second. 
Perhaps this field produces $800 net. If this is the case, 



THE PRODUCTIVITY OF CAPITAL 



249 



the farmer will no longer regard the total product of the 
second field as the product of the auxiliary capital alone. 
This auxiliary capital is credited with no larger product 
than that of auxihary capital on the third field — $800. 
The other $100 now comes to be considered as the prod- 
uct of the land. At the same time, of course, a second 
$100 is subtracted from the product of auxiliary capital 
on the best grade of land. And as the farmer adds unit 
after unit of auxiliary capital and opens field after field 
to tillage, the productivity of auxihary capital steadily 
shrinks and that of the better land as steadily increases. 
Perhaps the tenth field yields a net return of only $100. 
In such case no one of the ten units of auxiliary capital 
can be said to yield more than this. The use of no one 
of the units is worth more to the farmer than $100, for 
if any one were taken away from his control, he would 
replace it with the one employed in connection with the 
poorest field. 

In a grist mill the amount of capital which may be in- 
vested in machinery varies within wide limits. Once the 
mill is equipped with machinery, it would be difficult to 
increase greatly the amount of capital invested in ma- 
chinery, since not more machines, but better ones, would 
here be the result of increased investment. We may, 
however, suppose that^in determining upon the kind of 
equipment to be employed, an enterpriser goes through 
some such calculation as the following: — 

Given a building and a certain minimum of auxiliary 
capital . invested in machinery — say $10,000, an annual 
return of $10,000 may be secured. How much of this is 
the product of the building? how much is the product of 
the machinery? No one can say; neither form of capital 
would produce anything without the other. Increase the 
capital in machinery by another $10,000 unit; the net 
return increases, we will say, to $15,000. The sum added 



250 INTRODUCTION TO ECONOMICS 

by the second unit of auxiliary capital is $5000; as the 
two units of auxiliary capital are interchangeable, neither 
will be credited with more than this. Thus $5000 de- 
taches itself from the joint product of building and ma- 
chinery, and is credited to the building. Add another 
$10,000 unit in the form of machinery. The return in- 
creases to $17,000. $2000, then, is the product that can 
be credited to this unit of auxiliary capital, and no one of 
the three units will be credited with more than this. The 
building thus comes to be credited with $11,000, the sum 
remaining after the product of the three units of auxiliary 
capital has been deducted. 

The principle involved in this example may be stated 
as follows: The productivity of any unit of capital em- 
bodied in a given class of capital goods is measured by 
the amount added to the aggregate net product of a 
business by that unit which it is least worth while to 
employ. 

11. An increase in the capital of any establish- 
ment, attended by no parallel increase in 
labor, reduces the productivity of capital 
and increases that of labor. 
Suppose that a farmer can command practically an in- 
definite amount of agricultural capital, whether in the 
form of land or in the form of movable capital goods, but 
that the amount of labor that he can secure is limited to 
ten men. With $5000 invested partly in land, partly in 
movable capital goods, he may be able to produce $5000 
net. We should here find difficulty in determining what 
part of this sum is produced by the labor, what part by 
the capital. An additional $5000 of capital may increase 
the aggregate product of the business by $4000. This 
sum we should properly ascribe to the new capital. And 
as this second unit of capital does not differ in any essen- 
tial respect from the unit at first employed, and as the 



THE PRODUCTIVITY OF CAPITAL 251 

removal of one unit of the two would have the same 
effect as the removal of the other, we may properly re- 
gard them as equally productive. The extra thousand 
appearing in connection with the first unit must then be 
credited to the other factor in production — the labor. 
If a third unit of capital increases the product of the 
business by $3000, this amount will measure the impor- 
tance of any one of the three units of capital. This is 
what the farmer would lose if he were deprived of the 
use of any of the units. If a fifth unit adds only $1000, 
the product assignable to any unit shrinks to that figure. 
And of course with each reduction in the product assign- 
able to capital, the product assignable to labor increases. 

12. // the capital of an industry, or the capital 
of all society, increases, the productivity of 
capital declines. 

Up to the present point our study of the productivity 
of capital has been confined to the single business estab- 
lishment. We must now consider whether similar prin- 
ciples are apphcable to an industry in its entirety. The 
iron and steel industry of the United States may serve 
as our type. 

Let us say that the capital engaged in the production 
of iron and steel is $3,000,000,000, the number of men, 
400,000. Now let us suppose that without any revo- 
lutionary change in the demand for iron and steel the 
capital of the industry is increased by $100,000,000. 
What will be the effect upon the productivity of capital 
in the industry? 

It is fair to assume that before the increase in capital 
those branches of the industry promising the highest prof- 
its were already well developed ; that the richest deposits 
of ore and coking coal were already being exploited; that 
the best manufacturing sites had been selected. To what 
use, then, will the new capital be put? Some of th^ 



252 INTRODUCTION TO ECONOMICS 

enterprisers may attempt to duplicate existing plant. 
This requires additional labor, and such labor is to be had 
only by inducing new men to enter the industry or by 
enticing men away from other iron manufacturers. In 
either case an advance in wages will follow, which will 
soon become general throughout the industry. In the 
old establishments as well as the new this will obviously 
reduce the share of the aggregate product which capital 
will receive. Again, the increase in iron and steel prod- 
ucts thrown upon the market will lower prices. Thus, 
while the wages bill of an establishment per unit of 
product will increase, the value of each unit of product 
will diminish. 

If all the new capital is used simply to duplicate exist- 
ing plant, wages will rise to a decidedly higher level. 
The industry will need one tenth more men than it has 
at present, and these will be slow to appear unless they 
are offered high wages. The fall in prices, moreover, will 
be a serious one, as the output will be increased about 
ten per cent. But when the prices of the staple products 
of an industry fall, it often pays to develop new branches 
of the industry that under earlier conditions were not 
profitable. When wages rise, it pays to introduce ma- 
chinery that saves labor. Part of the new capital will 
be absorbed in these ways, and thus the productivity of 
capital will be prevented from sinking to as low a level 
as would otherwise be the case. The fact remains that 
the capital will be less productive after the increase than 
before it; wages will be higher and prices lower. The 
increase in the aggregate capital of the industry, 
other things equal, will reduce the productivity of 
each unit. 

The same principle is still more clearly applicable to 
industrial society as a whole. The iron and steel industry 
can relieve the pressure upon its labor supply by indue- 



THE PRODUCTIVITY OF CAPITAL 253 

ing men to leave other industries. If the capital of so- 
ciety as a whole increases, a pressure is placed upon the 
labor supply, for which there is no ready means of relief. 
The existing capital is normally sufficient to provide 
every one who desires to work with the necessary appli- 
ances. If, then, the capital of all industries increases 
more rapidly than the population, the average capital 
employed with each laborer must increase. Such in- 
crease in capital must be embodied in improvements 
upon existing appliances, and, owing to the operation of 
the law of diminishing returns, will increase the product 
of industry less than an equal amount of capital does 
when the social fund is smaller. 

13. The opening of new opportunities for invest- 

ment may counteract the eject of increase in 
capital. 
There are of course conditions under which an increase 
in capital may not be followed by a reduction in the 
productivity of capital. If, for example, the labor supply 
increases as rapidly as the supply of capital, there is no 
reason why the productivity of capital should decline. 
Again, suppose that some practical method of draining 
extensive swampy regions or of irrigating vast tracts of 
arid land were discovered. The new capital might be 
absorbed by the opening of these fields. In the last 
century, though capital has increased enormously, there 
has been a corresponding enlargement of the field of in- 
vestment; accordingly, the productivity of capital has 
declined little, if at all. 

14, An increase in artificial capital, while re- 

ducing returns on that form of capital, is 
likely to increase the returns from natural 
capital. 
It has already been indicated that by placing more and 
more auxiliary capital upon a given area of land one 



254 INTRODUCTION TO ECONOMICS 

must ordinarily reduce the productivity of auxiliary capi- 
tal and increase the productivity of land. It will natu- 
rally be the aim of the business man to keep his capital 
uniformly productive; if he has too much auxiliary cap- 
ital he will endeavor to get more land, and vice versa. 
He will ask himself: Would it pay me better to invest 
my next $1000 in land or in auxiliary capital? And he 
will continue to direct his investments toward whichever 
of these classes of capital goods is for the moment the 
more productive, until the superiority of that class dis- 
appears. 

Similarly, an entire industry may expand with more or 
less symmetry, distributing its new capital among the 
various classes of capital goods of which it stands in 
need. If the beet sugar industry expands, not only are 
more factories constructed, more machinery for the culti- 
vation of beets purchased, but more land is drawn into 
the service of the industry. This land is, of course, taken 
away from other industries — from wheat culture, dairy- 
ing, etc. 

When the social fund of capital increases, on the other 
hand, it is not possible for a symmetrical increase in all 
classes of capital to take place. The land, we may sup- 
pose, is already almost all in use; the best mines are 
opened; the most available courses for railways and 
canals are already occupied. These things the new cap- 
ital cannot duplicate; their relative importance, there- 
fore, steadily increases. On the other hand, steel rails, 
locomotives, factory buildings and thousands of other 
forms of capital goods are readily duplicated. The mar- 
ginal productivity of capital in these forms naturally 
declines, and a larger part of the product is left to be 
divided between labor and natural capital. 



THE PRODUCTIVITY OF CAPITAL 



255 



15. When the return to natural capital varies 

from the return to artificial capital, equal- 
ization is commonly brought about by re- 
valuation. 
When, however, we speak of the productivity of capital 
in general we usually take as our test the productivity of 
new capital — and this, we see, is practically the capital 
in goods which are capable of dupHcation. And instead 
of thinking of the old capital in nondupKcable goods as 
more than normally productive, we are likely to revalue 
the capital in such forms. Ten years ago, let us say, 
a five-acre lot gave as large a net product as a threshing 
machine. To-day the same piece of land yields twice 
as large a net return as a threshing machine equal in 
value to the one of ten years ago. We might say that 
the capital in land has doubled in productivity. But it 
is more usual to say that to-day the land represents 
twice as much capital as the threshing machine, although 
it represented no more capital than the threshing machine 
ten years ago. By a similar process of revaluation, the 
productivity of all capital which is abnormally produc- 
tive is reduced to the general level. This process of 
revaluation will receive our further attention in the next 
chapter. 

16. The productivity of artificial capital varies 

at any particular time from industry to 
industry, but tends constantly toward a 
uniform level. 
Even capital which is embodied in capital goods that 
are capable of reduplication may at any given time vary 
widely in productivity from establishment to establish- 
ment, or from industry to industry. It is only by experi- 
mentation that the actual productivity of capital can be 
determined, and owing to the changing character of 
modern industry the process of experimentation must go 



256 INTRODUCTION TO ECONOMICS 

on without ceasing. Accordingly, there are always 
chances of mistakes in investments. A cotton manu- 
facturer may overestimate the productivity of capital 
in a given type of loom; after purchasing and installing 
the machine he must content himself with what it will 
produce, even though he knows that the same amount 
of capital would in another form yield a far higher re- 
turn. Cotton manufacturers as a class may overestimate 
the future demand for cotton goods, and so may be led 
to invest heavily in buildings and machinery which prove 
incapable of returning the normal rate of interest on 
capital. At the same time the shoe industry may be 
undersupplied with capital; for a time, at least, every 
one hundred dollars invested in the industry may yield 
an abnormally high return. 

Such disparity in the productivity of capital in the two 
industries would, however, tend to disappear. The cap- 
ital invested in new cotton mills would, of course, be 
fixed in the industry for a long period of time. But in 
the industry as a whole there are always some mills that 
are about to be dismantled, having reached the limit of 
their useful existence. These mills have presumably 
earned in the past a sum sufhcient to replace themselves 
with new mills of a value equal to that of the original 
ones. If the cotton industry is suffering from a de- 
pression while the shoe industry is highly prosperous, 
the replacement fund will be diverted to the latter in- 
dustry. Through the reduction of capital in the cotton 
industry the productivity of capital in that field is in- 
creased; through the increase of capital in the shoe in- 
dustry the productivity of capital is reduced in that 
industry. It is easy to see that if this process continues 
for any length of time the original disparity in produc- 
tivity must disappear. 

The equalization of productivity is hastened by the 



THE PRODUCTIVITY OF CAPITAL 257 

disposition of new accumulations of capital. The fund 
of capital, under modern conditions, is constantly grow- 
ing in magnitude; consequently industries are, as a rule, 
expanding. The new capital naturally seeks the most 
productive fields. If, therefore, the rate of return in the 
cotton industry is abnormally low while that in the shoe 
industry is abnormally high, the new capital will avoid 
the former industry and seek investment in the latter. 
The influx of new capital into the shoe industry reduces 
productivity there, until at last capital is no more pro- 
ductive in the one industry than in the other. When 
this point has been reached, further additions to the 
supply of capital are divided impartially between the 
two industries, reducing productivity uniformly. 

It is, of course, possible that the productivity of 
capital in the two industries may never be absolutely 
equal. While the tide of new capital is setting steadily 
toward the shoe industry, a new demand for cotton goods 
or a new method of manufacture may appear and raise 
the productivity of capital in the cotton industry above 
that of the shoe industry. Some time will elapse before 
the change in the relative positions of the two industries 
is generally known; in the meantime the flow of new 
capital into the shoe industry continues. Eventually the 
new capital is diverted to the cotton industry; it may 
continue to flow in that direction after the cotton in- 
dustry has lost its relative superiority. We can only say 
that a tendency toward equahzation of productivity 
exists; not that equalization is ever exactly realized. 

17. Any barrier preventing the free flow of capital 
into an industry makes possible an abnor- 
mally high return on capital in that industry. 

It is, of course, to be remembered that the productivity 
of capital is not the only thing that an investor takes 
into account in deciding in what industry he shall invest 



258 INTRODUCTION TO ECONOMICS 

his savings. In some investments the danger of losing 
all or a part of the capital invested is great. Capital 
employed in developing the oil fields and timber re- 
sources of Russia may be highly productive; but the 
existing government of Russia from which the right to 
exploit oil or timber is derived, may be overturned, and 
a new government may confiscate the capital invested 
in the business. Capital invested in street railways may 
be very productive. But if cities do not follow a consist- 
ent policy in chartering new companies, it is possible 
that at any time rival lines may be established on parallel 
streets and, if unable to make large returns themselves, 
they may, nevertheless, reduce the return on capital in- 
vested in the original lines to almost nothing. The cap- 
ital still remains in the possession of the investor, but 
it is ''dead capital." A merchant's capital, invested in 
a fancy fabric, may promise high returns; but a sudden 
change in fashion may force the merchant to sell the 
goods at a price which not only yields no return on the 
capital invested, but which entails an actual impairment 
of the capital fund itself. 

Some risk, it is plain, inheres in every business; in 
some fields of investment, however, the risk is so small 
as to be negligible, while in other fields no prudent in- 
vestor can disregard it. Other things equal, the vast 
majority of investors will prefer to invest in the safer 
fields. A disproportionately large share of the capital 
of society, therefore, seeks the safer investments, and as 
a result the productivity of capital in such investments 
falls below the rate of return to capital in the more haz- 
ardous investments. And thus it is that there appears 
a regular variation in the productivity of capital corres- 
ponding with variations in risk. 

It is, of course, clear that it is not actual risk, but esti- 
mated risk, that affects the distribution and hence the 



THE PRODUCTIVITY OF CAPITAL 259 

productivity of capital. It is quite possible that the 
risk of losing capital invested in banking in Texas is 
less than the risk of losing capital similarly invested in 
New York. But if most of the persons having capital 
to invest mistakenly believe that the reverse is true, 
a disproportionately large part of the flow of new capital 
will enter the New York investment field and reduce the 
productivity of capital there below the level prevailing 
in Texas. 

In an earlier chapter we saw that risk affects wages 
only in so far as it affects the distribution of labor; 
further, that if enough reckless workmen can be found 
to man the dangerous trades, risk will not affect wages 
at all. Exactly the same thing is true of capital. If 
there were enough investors who always chose the more 
remunerative employments for capital, regardless of risk, 
the hazardous fields would soon be so well supplied with 
capital that they would yield no higher returns than the 
safer ones. As a rule, however, capital is far more timid 
in assuming risks than labor. It is therefore more anom- 
alous to find capital in a hazardous field yielding only 
normal returns than it is to find workmen in dangerous 
occupations receiving only normal wages. 

Risk, then, may be regarded as a barrier which pre- 
vents capital from flowing freely into some of the more 
productive fields. It is of course not the only natural 
barrier affecting the flow of capital. If a particular in- 
dustry is subject to the universal moral disapproval of 
a community, most capitalists will refuse to invest in it. 
Those who are unscrupulous enough to do so may enjoy 
the high returns that flow from an industry that is under- 
supplied with capital. Thus, high returns are often ob- 
tained from capital invested in contraband stills, gambling 
dens and opium "joints." It is, of course, possible that 
the investment institutions of a country may be of such 



26o INTRODUCTION TO ECONOMICS 

a nature that a man can hold stock in disreputable enter- 
prises without the knowledge of his associates, and that 
investors who have no personal scruples are numerous. 
Under these conditions the productivity of capital in 
such ventures will eventually fall to the normal level. 

18. Summary. 

Material goods which serve as means of production are 
known as capital goods. In the normal course of indus- 
try, each capital good, before it is sold or worn out, 
makes at least a sufficient addition to product to replace 
itself with an equally valuable capital good; and under 
normal conditions, each capital good, when worn out, is 
actually replaced. Capital goods may therefore be re- 
garded as a self-perpetuating fund of productive wealth. 
This fund is termed productive capital; it is to be dis- 
tinguished from those forms of wealth, also commonly 
termed capital, which add nothing to the product of 
society, although they enable their owners to secure an 
income. Under certain conditions, it is necessary to dis- 
tinguish between that productive capital which is the 
product of industry and that which is the free gift of 
nature. The former may be termed artificial, the latter 
natural, capital. 

The productivity of each capital good can be ascer- 
tained only through experimentation. A distinction must 
be made between the gross product of a capital good 
— the total value product originating in it — and its net 
product — the sum of value remaining after deduction of 
the expense of repairs or replacement. The net product 
of capital goods may be regarded as the product of the 
fund of such goods, or capital. 

The productivity of capital invested in any class of 
goods is determined by the addition to net product made 
by those goods of the class that perform the least im- 
portant functions. Every increase in the amount of capi- 



THE PRODUCTIVITY OF CAPITAL 261 

tal invested in a given class of goods tends to reduce the 
productivity of each unit of capital in that class, 
and to raise the productivity of capital invested in 
other classes of goods, as well as the productivity of 
labor. Natural capital often fails to increase as rapidly 
as artificial capital; consequently, for long periods of 
time the productivity of natural capital goods tends to 
increase, while that of artificial capital goods tends to 
decline. Equalization of returns to the two classes of 
capital can be brought about only through revaluation 
of the natural capital goods. The earnings of capital 
in the different classes of artificial capital goods tend, 
under competition, toward a uniform level; in many 
cases, however, barriers preventing the free flow of capi- 
tal keep the earnings of capital in one field permanently 
higher than in another. 



CHAPTER XIV 
RENT, INTEREST, AND CAPITALIZATION 

1. Rent, in everyday speech, is a payment for the 
temporary use of durable goods. 

In popular usage the term "rent" is applied to any 

payment which one person makes to another for the 

temporary use of a concrete good or group of goods. 

Thus rent may be paid for the use of a farm, a house, 

a piano, a square yard of advertising space on a bill 

board. In the nature of the case, only those things can 

be rented which remain practically intact through the 

period of use. One never rents a bin of coal or a stock 

of merchandise. Nor does one ever rent goods which 

can serve their purpose only by entering into permanent 

combination with other goods. No one would think of 

trying to rent steel beams to be used in the construction 

of his house. The more nearly indestructible a good is, 

and the more perfectly it yields up its services without 

losing its identity, the better is it adapted to the renting 

contract. Thus a field, being practically indestructible, 

may very well be rented for a period of years, although 

if its cultivation requires the incorporation of a large 

amount of auxiliary capital in the soil, in the form of 

drains or irrigation ditches, the field and the auxihary 

capital must usually be rented together. A piano, which 

is much more likely to be injured, nevertheless lends 

itself fairly well to the renting contract because no other 

capital good enters into permanent combination with it 

in use. 

262 



RENT, INTEREST, AND CAPITALIZATION 263 

2. The term rent has been commonly used by 

economists to designate income arising from 
natural agents. 
In the classical economic terminology, rent included 
all income from permanent natural agents, whether these 
agents were leased or employed in production by their 
owners. A field, a building site, or a waterfall, it was 
said, yields rent. Incomes from houses, machines, and 
other reproducible goods were called interest on capital. 
The word rent is used in the classical sense by a large 
number of our living economists. While the term will 
be given a different meaning in this book, we shall recog- 
nize rent in the traditional sense under the name ground 
rent. 

3. The term rent in its broadest sense includes 

the products of all capital goods, whether 
rented by the enterpriser or owned by him. 
If a man owns and manages a farm which he could let 
at a rental of $1000, we may say that $1000 out of his 
income is really the rent of his farm. True, he does not 
pay this sum to any one; but neither does he pay any 
one wages for the labor which he himself performs. It 
would be absurd, however, to say that a man earns no 
wages when he is working for himself. As employer he 
pays himself wages as workman. In like manner, the 
man who cultivates his own field may be thought of as 
paying rent, as cultivator, to himself, as landlord. So, 
if an ocean transportation company owns and sails a 
ship which it could let for $5000 a year, we may regard 
$5000 out of the proceeds of the company's business as 
the rent of this particular ship. In this broad sense of 
the term, rent may be defined as that part of the pro- 
ceeds of a business which is economically due to a par-^ 
ticular capital good. It is the economic product of a 
capital good, regarded as a lump sum. And as even 



264 INTRODUCTION TO ECONOMICS 

the most perishable of capital goods yield a product 
which may be measured in this way, we may strain the 
ordinary meaning of the term rent so as to include the 
concrete products of all capital goods whatsoever. 
4. For practical reasons, a study of rent may 

test he confined to the products of goods that 

have a high degree of permanence. 
While the term rent may, as has been said, be applied 
to the product of any concrete capital good, we shall in 
this chapter confine our study to the rent of those classes 
of goods that are of such a nature as to permit the trans- 
fer of their uses under renting contracts. The distinguish- 
ing characteristic of this class of goods is that the capital 
embodied in them is fixed there, for a considerable period 
of time at least. It takes perhaps ten years before the 
capital invested in a boat can migrate to some industry 
upon the dry land. That is the time necessary for the 
funds accumulating for the replacement of the ship to 
equal its original value. The capital embodied in a well- 
built house may be fixed there for fifty years; and the 
capital invested in a field, in a tunnel, or in an excavation 
must remain where it is forever. It is true that you may 
take your capital out of a field; this you do when you 
sell it. But what you really do when you sell the field is 
to transfer to another person your claim to the capital it 
represents. The capital in the field is the same after the 
transaction as it was before it. Such permanently in- 
vested capital may be contrasted with the capital invested 
in transitory forms, as coal, raw materials, merchants' 
stocks. The capital invested in these forms returns to its 
owner in a relatively short time in the form of purchasing 
power, and may be reinvested in any one out of a thou- 
sand different classes of capital goods. The return to 
such transitory goods is most conveniently calculated as 
a percentage return to the capital invested in them. It 



RENT, INTEREST, AND CAPITALIZATION 265 

is natural to think of the return to a farm or a building 
as a certain sum of money, or a rent. One may, of course, 
translate the rent into terms of interest on the capital in- 
vested in the farm or building. On the other hand, it is 
natural to think of the return to a merchants' stock in 
trade as interest on the capital invested in the stock, al- 
though it would be quite possible to arrive at the returns 
to the stock by adding together the net products of all the 
capital goods whose services have been used. 
5. Gross rent is the total product of a capital good; 
net rent is whatever remains of the product after 
deductions have been made for the repair and 
replacement of the capital good. Net rent is 
identical with interest. 
We must be careful to distinguish between the total 
product of a capital good, or its gross rent, and that part 
of the product remaining after the cost of depreciation of 
the capital good has been deducted, or net rent. To ar- 
rive at the net rent of a house we must deduct from the 
gross rent a sum sufficient to meet the cost of repairs, 
together with a year's proper contribution to a fund for 
the replacement of the house when it shall cease to be 
habitable. Even the payment for the use of a field is a 
gross rent. The field wears out — that is, it loses through 
cropping a part of its original or acquired fertility. The 
owner of the field must, therefore, set aside a part of the 
product of the land to restore, the fertility of the soil. 

It will be noted that net rent, in the sense in which the 
term is used here, is nothing but interest under another 
form. We will say that a house yields a net rent of 
$1000. This $1000 is the sum of interest on the capital 
invested in the house. If this capital is $10,000, each 
$100 of it yields an income of $10. In other words, the 
rate of interest is ten per cent. In general, if we reduce 
the rent of a group of capital goods to a percentage of the 



266 INTRODUCTION TO ECONOMICS 

capital embodied in them, what we have is interest on 
this capital. 
6. The rent of the permanent goods used in an 
enterprise is most conveniently treated as a 
residue remaining after the wages of labor, 
charges for the use of capital in perishable 
forms, and the cost of materials and other 
perishable goods have been deducted from the 
total product of the enterprise. 
In the last chapter we saw that there are two ways of 
arriving at the product of a concrete capital good, or its 
rent. One way is to withdraw the capital good from the 
productive combination into which it enters, noting the 
shrinkage in product that follows. The other way is to 
deduct from the gross receipts from a group of several 
goods the shares (if these can be independently ascer- 
tained) that are due to all of the goods except one. What 
is left is of course the product or rent of the remaining 
good. Either method may be employed in ascertaining 
the rent of many capital goods; but the latter method is 
most frequently employed in the case of goods that lend 
themselves readily to the renting contract. If one wishes 
to rent a steam thresher, for example, he will first of all 
inquire what the gross earnings from the operation of the 
machine are likely to be. Perhaps such earnings will 
average $40 a day. In order to operate the thresher, it 
is, of course, necessary to employ labor and auxiliary 
capital goods — as coal and machine oil — in connection 
with it. The labor must be paid for at the prevailing 
rate of wages; coal and oil must be paid for at the market 
price. There are accordingly definite sums that must be 
deducted from the gross receipts from the operation of 
the machine Whatever is left after these charges have 
been met — possibly $20 — is the gross rent of the 
machine for the day. 



RENT, INTEREST, AND CAPITALIZATION 267 

In the foregoing example the cost of labor, of coal, and 
of oil were regarded as preferred charges upon the earn- 
ings of the enterprise, and this indeed they are. The 
operator of the threshing machine must pay at least the 
prevailing rate of wages, or he cannot get labor to run 
the machine. Similarly, he must pay the market price of 
coal. Labor and coal have a multitude of uses outside of 
the business of threshing; if not properly rewarded in that 
business they go elsewhere. The machine, on the other 
hand, cannot seek other employment. It is committed 
to a particular function; consequently it cannot enforce 
any claim for a specific remuneration. The machine is, 
as it were, a residuary claimant; and this is more or less 
true of most of the capital goods that are actually rented. 
Economists therefore find it convenient to treat rent as 
though it were always determined in this way. 

A steamship building company, not having sufficient 
orders on hand, launches a freighter on its own account, 
trusting to the chance that some ocean transportation 
company will be ready to pay a fair rental for its use. 
What will determine the rent that the transportation com- 
pany will offer to pay? The managers of that company 
can probably estimate pretty accurately what the gross re- 
ceipts from a year's operation of such a ship would be. 
Let us say that the estimated gross receipts are $35,000. 
From this sum must be deducted the wages of officers 
and men, $7000; charges for pilotage, harbor dues, etc., 
$1000; the cost of coal and provisions, $10,000; mis- 
cellaneous expenses, $1000. Nor is this quite all. The 
$10,000 invested in coal and provisions — supposing that 
the transportation company must purchase the whole 
amount at the beginning of the year — is capital that 
would in any other field earn $500 interest. This sum 
must therefore be added to the preferred charges of oper- 
ating the ship. The $15,500 remaining out of the esti- 



268 INTRODUCTION TO ECONOMICS 

mated gross receipts is the maximum rent that the transpor- 
tation company can pay for the use of the ship. This 
sum, the gross rent of the ship, includes, however, pay- 
ment for the depreciation of the ship through one year's 
use. If this amounts to $10,000, we have remaining the 
sum of $5500 as the net rent. 

Similarly, the gross rent of a farm is found by deduct- 
ing from gross receipts a sum that is sufficient to pay the 
wages of all labor employed in cultivating it; to replace 
all capital goods used up; to keep up the efficiency of all 
live stock and machinery, together with interest at the 
prevailing rate on the capital invested in such movable 
capital goods. To arrive at the net rent we must deduct 
from the gross rent thus determined whatever may be 
necessary to keep buildings, fences, etc., in repair, and to 
restore to the soil any elements of fertility that have been 
destroyed in the year's cropping. 

7. The rent of any one out of a number of classes 
of goods united in a permanent combination 
may be ascertained by comparison with other 
productive combinations in which some, but 
not all, classes are represented. 
In the cases that have been given the rent-yielding ob- 
ject is a group of capital goods, more or less securely 
bound together in use. The farm, for example, may be 
analyzed into several distinct factors. One factor is the 
bare land; another factor consists of improvements 
merged in the soil, as drains or irrigation ditches; a third 
factor consists of farm buildings, fences, tree plantations, 
etc. Some part of the rent must be ascribable to each 
one of these factors. The productivity of such a factor 
cannot be found by withdrawing it; nor can it be found 
by treating it as a residue, after ascertaining the shares of 
the other factors combined with it, for these shares can- 
not be ascertained directly. There remains the method 



RENT, INTEREST, AND CAPITALIZATION 269 

of comparisons. How much more will a well-drained field 
yield than another field in the vicinity, of apparently 
equal natural fertility, but without drains? By such 
comparisons it is usually possible to tell pretty nearly 
what each factor in a permanent combination of capital 
goods is producing. One may distinguish in this way be- 
tween the rent paid for a city house and the rent paid for 
the ground it stands on, although the two rents usually 
make parts of a single payment. Find an equally spa- 
cious and costly house in a suburb, where a building lot 
is to be had for practically nothing. The difference in the 
rent of the two houses is a fairly accurate measure of the 
rent of the city lot. 

8. The rent of an artificial capital good tends, in 
the long run, to equal interest, at the current 
rate, on the cost of duplicating the capital 
good. 
The rent of a ship, a building, or a machine, may, as we 
have seen, be ascertained, in the first instance, by sub- 
tracting from the gross receipts arising from its operation 
a sum covering all other expenses connected with its use. 
The value of such a rent-bearing object does not im- 
mediately affect the amount of rent it yields. A ship 
that yields a net surplus of $5000 above operating ex- 
penses may be worth $50,000 or $100,000. The value of 
the ship has nothing to do with the amount of rent that 
its owner will receive in the immediate future. But a ship 
is a capital good that requires periodic renewal. Out of 
1000 ships sailing the ocean to-day probably fifty are near 
the end of their economic existence, and will have to be 
replaced by new ships if the existing tonnage is to be 
maintained. Now, if the rent of ships happens to be so 
low as not to pay the ordinary rate of interest on the 
capital represented by the cost of building them, no new 
ships will be built to take the places of those that are no 



270 INTRODUCTION TO ECONOMICS 

longer seaworthy. The aggregate tonnage will thus be 
reduced; freights will be advanced until the rent of ships 
rises to a figure which affords a normal return to shipping 
capital. If, on the other hand, the rent of ships repre- 
sents an abnormally high return to capital, more ships 
will be built, and freights will decline until the rent of ships 
is only sufficient to pay a fair rate of interest on the 
capital invested in them. And this is in general true of 
the rents of all capital goods requiring periodic renewal. 
For a time the rent may be too high or too low to afford 
just a normal return to the capital invested in such goods. 
In the long run, however, the rent is controlled by the 
prevaihng rate of interest. 

9. The rent of land is dependent, in large meas- 
ure, upon the rate of wages and of interest on 
auxiliary capital. 

We have seen how it is possible to distinguish the rent 
of the bare land from the rent of the improvements fixed 
in it. The rent of land as such is of great practical im- 
portance, as land is more frequently held under lease than 
any other class of capital goods. For this reason, and 
because land rent displays certain peculiar characteris- 
tics, it is worth while to devote especial attention to a 
study of the laws determining it. 

Let us assume that the construction of a railway throws 
open to exploitation a large section of territory in the 
Canadian Northwest, and that all the land is at once bought 
up by wealthy persons who intend to hold it permanently, 
parceling it out in tracts suitable for tenant farmers. We 
shall further assume that the owners of the land leave its 
equipment with auxiliary capital goods entirely to the ten- 
ants, and that deterioration of the land through cropping 
is so slight as to be negligible. Whatever the tenant can be 
made to pay, under these conditions, is practically the 
rent of the bare land. 



RENT, INTEREST, AND CAPITALIZATION 271 

In making up his bid the tenant will have to estimate, 
on the one hand, the gross receipts from the land which he 
expects to occupy, and on the other hand, all expenses of 
cultivation, including the wages of all labor employed, his 
own as well as that of hired hands; interest on the aux- 
iliary capital which he furnishes, whether his own or bor- 
rowed capital; and a sum sufhcient to replace or repair 
capital goods destroyed or impaired through use. Let us 
suppose that all these items of expense amount to $1000. 
If the tenant has reason to beheve that one year with 
another the gross receipts from the farm will be only 
$1000 he will pay nothing at all to the owner of the land 
for its use. If on the other hand he believes that the 
gross receipts will be $2000 he will be prepared to pay 
a rent of $1000. 

It is obvious that what the tenant can afford to pay for 
the use of the land depends, in large measure, upon the 
rates at which he must reckon the wages of labor and in- 
terest on auxiHary capital. If these rates are high, the 
deductions from gross receipts to be made in calculating 
rent will be large. Accordingly, in order to arrive at the 
forces determining the rent of land in the section which 
we are studying, we must examine the influences affecting 
the local rates of wages and interest. 

Land in the Canadian Northwest, as in every other part 
of the world, varies in natural fertility and in accessibility. 
If the supply of auxiliary capital and of labor is very 
small, only the most fertile and most accessible lands will 
be cultivated. The owners of slightly poorer or slightly 
less accessible lands will of course derive no revenue from 
them; they could afford to let such lands for a nominal 
rent. On these lands, then, labor and auxiHary capital 
are free to divide between them whatever they can pro- 
duce. The labor and auxiliary capital employed on the 
better land can demand at least as much for themselves; 



2 72 INTRODUCTION TO ECONOMICS 

if this is refused, they will migrate to the unoccupied 
fields. 

Now let us suppose that a new body of laborers, bring- 
ing with them the appropriate auxiHary capital, enter the 
region. These occupy the lands which in fertiUty and ac- 
cessibility are least inferior to those first cultivated. If 
after this accession of labor and capital any one is dissatis- 
fied with wages on the better lands, he may, as before, 
migrate to land still remaining unoccupied. But the un- 
occupied land is now more remote and less fertile than 
was that existing before the accession of the new labor 
and capital, and the product of labor and capital on such 
lands will be less. The cultivator of the better grade of 
land will therefore not have to pay so much for either 
factor as before. A larger share of his gross receipts may 
therefore be paid out in rent. And with every increase in 
the labor and auxiliary capital of the community, remoter 
and less fertile lands are brought under cultivation, with 
consequent decline in wages and in interest on auxiliary 
capital, and increase in the rent of all the better grades of 
land. At any particular time we may say that in this 
community the wages of labor and the interest on auxil- 
iary capital are determined, respectively, by the pro- 
ductivity of labor and of auxiliary capital on the poorest 
land actually cultivated. This is of course only a special 
instance of the law stated in earlier chapters, that wages 
and interest ^re determined by marginal productivity. 

From the fact that when labor and capital flow into a 
new region the rent of land steadily rises, it is often as- 
sumed that the aggregate of land rents is constantly in- 
creasing. But it is to be borne in mind that when labor 
and capital are drawn into a new region, the older com- 
munities may come to be less fully supplied than before. 
And this would increase the shares of labor and of aux- 
iliary capital in those communities, and reduce the share 



RENT, INTEREST, AND CAPITALIZATION 273 

that is assigned to land. The increase in rents in Amer- 
ica, in the last half century, has in some measure been 
offset by a dechne in rents in Europe. If, however, pop- 
ulation and capital in reproducible forms continue to in- 
crease, without any corresponding increase in the amount 
of land accessible to the cultivator, and without improve- 
ments that increase the general productivity of labor and 
capital, the aggregate of land rent must increase. 

10. A rise in the prices of agricultural products 
usually raises the rent of land. 

In the foregoing example we have assumed that the 
value of the product of a farm remains fixed, while the 
rates of wages and interest vary. Let us now see what 
would be the effect on rent of an increase in the value of 
the product — which we shall assume to be wheat. Such 
an increase might be brought about by a reduction in the 
cost of transportation. For the local price of wheat is 
practically equal to the price in England, the great wheat 
market of the world, less the cost of transporting the 
wheat thither. If the cost of transportation is reduced 
five cents a bushel, the local price of wheat will rise five 
cents a bushel. 

If the growers of wheat are forced to rely upon the 
local suppHes of labor and capital, the effect of the rise in 
the price of wheat will be an increase in wages of labor 
and interest on auxiliary capital as well as in the rent of 
the land. For under the conditions assumed, wages and 
interest are determined by the value of the product of 
these agents on the pooorest lands in the community act- 
ually in use. The value of this product will be increased 
by the rise in the price of wheat; hence wages and inter- 
est will rise throughout the territory. Since there has 
been no increase in the amount of labor and capital, no 
more land can be cultivated than before. The better 
lands can claim no larger a return, measured in wheat, 



2 74 INTRODUCTION TO ECONOMICS 

than before; but this return now commands a higher 
price. 

If, on the other hand, close relations have been estab- 
lished between this region and the rest of the world, so 
that wages and interest are determined by the general in- 
fluences prevailing in society, practically the whole of the 
advance in wheat prices will be applied to rent. For sup- 
pose that at first wages and interest are raised above the 
general level. Additional labor and capital will flow into 
the region; competition will arise for employment on the 
better lands, or worse lands will be put under culitvation. 
Thus the marginal productivity of labor and of auxiliary 
capital will be reduced and the rent of land will increase 
until labor and capital are rewarded no better than they 
were before — that is, until land rent has absorbed the 
entire benefit of the increase in price. It is true that the 
withdrawal of labor and capital from the general field that 
this movement implies will tend to raise the rewards of 
these agents slightly. But this influence will be hardly 
perceptible. 

We can now understand what it is that forces up agri- 
cultural rents in the vicinity of a growing city. The value 
of the gross product of a given area is constantly increas- 
ing, as a result of increased demand, while the charges to 
be deducted, wages and interest on capital in reproducible 
forms, are controlled by general laws which are affected 
only slightly, if at all, by the growth of this particular 
city. We can explain in the same way the rise of rent of 
city lots. The aggregate return from the business that 
may be transacted on a given ground space increases with 
the growth of a city, and as wages and interest on repro- 
ducible capital do not increase in equal degree, a larger 
surplus is left for the owner of the land. In the same way 
the rent of a railway or a canal in a rapidly developing 
region steadily increases. The railway or canal is a cap- 



RENT, INTEREST, AND CAPITALIZATION 275 

ital good which cannot readily be reproduced. Accord- 
ingly, if the aggregate business to be carried on increases, 
an increasing share of the value product of the business 
will take the form of rent on the irreproducible elements. 

11. Growth of population and increase in accumu- 

lations tend to raise ground remits generally. 
In all the cases that we have examined, an important 
factor in raising rents of land and similar capital goods is 
the influx^, or possibility of influx, of capital and labor 
from the general field. If we view society as a whole, there 
is, of course, no possibility of a similar influx of labor and 
capital from outside regions. Nothing can transfer to the 
owners of land the benefits of increased value product except 
increase in the aggregate supply of labor and auxiliary 
capital. If these agents remain stationary in quantity, 
while the progress of improvements raises the pro- 
ductivity of the units that are placed at the greatest dis- 
advantage — that is, if general wages and interest rise — 
it is obvious that the rent of land may fall. So also if 
population and auxihary capital decrease in amount. If, 
on the other hand, labor and auxiliary capital increase so 
rapidly that wages and the interest on such capital fall, 
land rents must, in general rise. It is, of course, possible 
that increase of capital and of labor may be attendiftd by 
such great improvements in methods of production that 
wages, interest on reproducible capital goods, and land 
rent will all increase. This has been more or less true of 
the economic development of the last century. 

12. The process of computing the amount of cap- 

ital in a good from its net rent is termed 
capitalization. . '^ ■ 

Given the net rent of a capital good which cannot be 
reproduced and the current rate of interest on capital, it 
is an easy matter to ascertain the amount of capital in- 
vested in the good. Multiply the sum representing the 



276 INTRODUCTION TO ECONOMICS 

usual net rent by the quotient arrived at by dividing loo 
by the number representing the rate of interest. If the 
net rent of a farm is $2500 and the current rate of inter- 
est is five per cent, the capital value of the farm is ^^ 
X $2500, or $50,000. This process of computing the capi- 
tal through the net rent is known as capitalization. If a 
building earns $10,000 a year, and there is good reason 
for beHeving that it will continue to earn the same net 
rent indefinitely, the simplest way of ascertaining how 
much capital is invested in the building is to find how 
large a sum of capital, in general investments, is required 
to earn an equal sum. If the general rate of interest is ten 
per cent, this sum will be $100,000. If the rate of interest 
is five per cent, the sum will be $200,000. In the one case 
the rent is capitalized at ten per cent, in the other case at 
five per cent. 

13. The amount of capital in a reproducible capi- 
tal good is determined by its cost of duplica- 
tion. The amount of capital in capital 
goods that cannot be replaced is determined 
by the capitalization of their rent. 
In the case of reproducible capital goods, the net rent 
alone is no sufficient indication of capital value. The cost 
of producing similar goods must be taken into account; 
indeed, this is by far the more important element in the 
computation. A ship, for example, may yield a net rent 
of $10,000 at a time when the current rate of interest is 
five per cent. He would, however, be a reckless business 
man who would assume, from these data, that the ship 
represented a capital of $200,000, and that he could afford 
to pay that sum for it. If a similar ship can be built for 
$100,000, this sum is the true measure of the capital in- 
vested. The net rent of $10,000 merely indicates that 
capital in ships is, for the time, highly productive. Soon 
the supply of ships will, doubtless, be increased and the 



RENT, INTEREST, AND CAPITALIZATION 277 

net rent will fall to about $5000. It may be a year before 
the decline will take place; in such case the buyer of a 
ship already afloat can afford to pay about $105,000 for 
it. This sum may be analyzed into two parts; $100,000 
for the capital in the ship, and $5000 for the transfer of 
the extra productivity of the ship through one year. If 
several years must elapse before the net rent of ships falls, 
the second element in the price of the ship will be placed 
at a higher figure; and if in some way this extra pro- 
ductivity could be made perpetual — if the ship, worth 
originally $100,000, could be made to yield indefinitely 
$5000 in addition to the normal earnings of the capital 
invested in it — the buyer could afford to pay as much 
for this extra product as for the original capital. That is, 
he would arrive at the value of the ship, not through a 
computation of its cost of production, but through a cap- 
italization of its entire net rent. 

Now, a tract of land is a capital good in a situation 
analogous to that of the ship in our hypothetical case. 
The capital invested in the land, in the first instance, may 
have been nothing at all. But if the land yields a net 
rent of $5000 a year and there is good reason for beheving 
that this rent will be maintained, that fact is the only one 
that buyer or seller will need to consider. For it is not 
possible that the supply of similar pieces of land at the 
command of society will be so increased that the net rent 
will shrink to zero, as would be the case with a repro- 
ducible good originally costing nothing. Because of the 
natural limitation upon the supply of land, there is good 
reason for supposing that the existing rent will continue 
to be paid indefinitely. The right to receive the $5000 
land rent for all time is therefore worth just as much as 
the possession of a capital in reproducible forms yielding 
$5000 interest annually. If capital in reproducible goods 
yields, as a rule, ten per cent, the rent of the land will be 



278 INTRODUCTION TO ECONOMICS 

capitalized at $50,000; if the current rate on such capital 
is only five per cent, the rent will be capitalized at 
$100,000. 

There is, of course, always a possibility that land rent 
may decHne and its capital value shrink accordingly. 
Something of the kind happened to the rents and land 
values of Western Europe in the last quarter of the nine- 
teenth century, when the competition of American grain 
lowered the prices of the European product. Toward the 
close of the Great War and in the period immediately 
following, the rent of wheat and corn land in the Middle 
Western States rose to remarkable levels because of the 
high prices paid for grain. The value of land rose cor- 
respondingly, to sink back painfully with the fall of agri- 
cultural prices in 1920 and 192 1. 

Shall we say that a tract of land that yields $5000 rent, 
and is capitalized at $100,000, is really a capital of 
$100,000, or shall we say that the real capital in the land 
is only the sum originally employed to clear it and render 
it fit for economic use? If we adopt the former mode of 
expression, we shall regard the capital in the land as no 
more productive than capital in any other form. If we 
adopt the latter mode of expression, we shall regard the 
capital in the land as extraordinarily productive. Bus- 
iness men, and many modern economists, adopt the 
former mode of expression. A property that yields reg- 
ularly the income of a capital of $100,000 is a capital of 
$100,000. 

It matters little what mode of expression we employ so 
long as we bear in mind the fact that the value of the land 
is merely the capitalization of its rent at the current rate 
of interest; that with an increase in the rent of a given 
tract of land, if interest on capital in reproducible goods 
remains unchanged, the capital value of the land auto- 
matically increases, until the ratio of the capital value of 



RENT, INTEREST, AND CAPITALIZATION 279 

land to its net rent is the same as the ratio of the capital 
value of a group of typical reproducible capital goods to 
their net rent; that with a decline in the interest rate on 
capital in reproducible goods, the value of land yielding 
a given rent increases until the rate of interest on so- 
called capital in land is no higher than the rate of interest 
on other forms of capital. If the rate of interest on capi- 
tal in reproducible capital goods falls, it is because the 
earning power of such goods declines. If the rate of in- 
terest on capital in land declines, it is usually because the 
land is revalued at a higher figure — that is, counts for a 
larger sum of capital. 

14. Increase in the capital of society causes the 
value of land to rise for two reasons, (i) 
because it raises the rent of land, and (2) 
because it lowers the rate at which a given 
rental is capitalized. 
We have already seen that with increase in the social 
fund of reproducible capital the productivity of such capi- 
tal declines; the rate of interest falls, and a larger share 
of the product of society takes the form of ground rent. 
This of itself would have the effect of increasing the capi- 
tal value of land. The decline of the interest rate affects 
the value of land further through lowering the rate at 
which a given rent is capitalized. If the current rate of 
interest is ten per cent, a certain field may produce a net 
rent of $1000. This sum, capitahzed at ten per cent, 
gives a value of $10,000, which we may, if we choose, 
call the capital invested in the field. At the end of two 
decades the current rate of interest may have fallen to five 
per cent. This would naturally increase the rent of the 
field in question ^ perhaps to $2000. This rent we must 
now capitalize, not at ten per cent, as formerly, but at the 
new current rate of five per cent. The value of the land 
thus comes to be $40,000. 



28o INTRODUCTION TO ECONOMICS 

15. Summary. 

Rent, in the most general sense of the term, is the 
product of any concrete capital good. For practical 
reasons, however, a study of rent may best be Hmited 
to goods of a fairly permanent character. The gross 
return to a capital good may be divided into two parts, 
one of which serves to replace the good when it is worn 
out, while the other is a net income to the owner of the 
good. This net income, or net rent, may be regarded as 
the sum of interest on the capital embodied in the good. 

In practice, the rent of a durable capital good may con- 
veniently be treated as a residue remaining after the cost 
of labor and of perishable goods has been deducted from 
the aggregate product. Where several durable goods en- 
ter into a permanent combination, the rent of any one 
may be determined by comparison with other combina- 
tions into which this particular good does not enter. 

The rent of reproducible capital goods tends, in the 
long run, to equal interest, at the current rate, on the cost 
of dupHcating such goods. The rent of goods that can- 
not be dupHcated, such as land, can be arrived at only 
through a study of the forces determining wages, interest 
on reproducible capital, and other outlays in production. 
As wages and interest fall, or as value of product rises, 
the rent of such goods increases. The value of irrepro- 
ducible capital goods is arrived at through a capitalization 
of their rent at the current rate of interest. In a develop- 
ing country land values rise on account of increase in 
rent and on account of decline in the interest rate serv- 
ing as a basis of capitalization. 



CHAPTER XV 
ENTERPRISE AND BUSINESS PROFITS 

1. Exceptionally favorable opportunities for the 
employment of labor and capital are to be 
found in every progressive society. 

In many parts of the United States a careful observer of 
business conditions will note neglected opportunities for 
the production of wealth. In one section of the country 
there is a great demand for thoroughbred stock; very high 
prices are paid for such stock, yet men are slow to equip 
themselves for meeting the demand. Another section of 
the country is known to present excellent opportunity for 
the production of high grade fruit, yet it has few orchards, 
and these of indifferent quaHty. Fertile lands are to be 
found that yield scarcely anything for lack of water, yet 
plenty of water for irrigation is at hand in a near-by 
stream. Waterfalls offering abundance of cheap power 
remain for years unutilized. 

Nor are exceptional opportunities for wealth production 
Hmited to the exploitation of neglected natural sources of 
wealth. The richest opportunities are often those of or- 
ganizing in a more effective way businesses already exist- 
ing. In a dairying district, when each producer works 
in ignorance of what other producers are doing, he must 
learn through experience many facts concerning methods 
of production and marketing that could be learned much 
more cheaply through the experience of others. More- 
over, the product of such a district lacks uniformity and 
its supply is very irregular, with the result that prices 

281 



282 INTRODUCTION TO ECONOMICS 

are unnecessarily low and fluctuate seriously. An organi- 
zation of the producers may decidedly increase their in- 
come. In a certain city there is a corner lot, now occu- 
pied by a tumble-down dwelling house, that would fur- 
nish an excellent location for a grocery or hardware business. 
A block of ground in the residence part of the city, now 
occupied by a few old cottages, could, in view of present 
conditions, be profitably cleared and sold in large lots to 
persons intending to build expensive homes. 

In earlier chapters we have seen what advantages flow 
from the concentration and combination of production. 
At a particular time there is one form of organization best 
adapted to the circumstances, and to introduce this form 
of organization offers an opportunity for rich reward to 
the man or men who are enterprising enough to under- 
take the task. 

It may be said, in general, that whenever a new busi- 
ness is undertaken, it is with the purpose of exploiting 
a preexisting opportunity for exceptional returns. The 
same thing is true when an established business enters 
new fields of activity. 

2. The function of combining labor and capital 
for the purpose of exploiting a business 
opportunity is known in economics as 
enterprise. 

In a growing town the time has become ripe for the 
establishment of a wholesale grocery business. Months 
and years may pass before any one undertakes to supply 
the need for such a business, but eventually a man of 
sufficient business prestige to command confidence pro- 
ceeds to get together the requisite funds for launching 
the business. He may be rich enough to supply the 
necessary capital himself; he may supply a part of it 
and borrow the rest; or he may associate with him in 
the enterprise other persons having capital. The or- 



ENTERPRISE AND BUSINESS PROFITS 283 

ganizing of the business involves labor on his part, and 
some of it of a very high order. The essential part of 
his activity is not, however, the labor involved. What 
differentiates him from a laborer working in a routine 
way is the fact that he sees a new opportunity clearly 
and takes the steps necessary to utilize it. And the re- 
ward which he anticipates consists, not in wages for his 
labor, but in the exceptional returns to all labor and 
capital he employs, from which he expects to retain a 
share for himself. 

The man who performs the function of combining labor 
and capital for the exploitation of an opportunity is 
known in economics as the enterpriser, or entrepreneur. 

To illustrate the functions of the enterpriser, we will 
suppose that a man of known integrity and business 
capacity decides to establish a manufacturing business. 
He borrows at a stipulated rate of interest all the capital 
that the enterprise requires. The actual work of the 
business man himself, we will say, is a negligible mini- 
mum. His secretaries collect the information on which 
he acts in deciding to found such a business. His attor- 
neys arrange the details of the loan contract; his banker 
finds for him the persons who have capital to lend. Even 
the work of selecting a building and choosing a respon- 
sible manager is given over to salaried employees. What, 
then, is the connection of the business man with the en- 
terprise? He lends it his name, he assumes legal respon- 
sibility for the conduct of the business, and he reserves 
to himself the ultimate power of approving or vetoing 
proposals made by his staff. These are the only functions 
that the enterpriser must necessarily retain. 

In real life it would be difhcult to find a man who is 
an enterpriser and nothing more. It is rarely the case 
that a man without capital can borrow any considerable 
amount of it. Lenders demand the security that only 



284 INTRODUCTION TO ECONOMICS 

the owner of independent resources can give. He would, 
moreover, be a fortunate enterpriser who could find 
secretaries and managers who could be trusted to the 
extent we have assumed. A part of the labor of over- 
sight must ordinarily be performed by the business man 
himself. The fact that the same man usually com- 
bines in himself the functions of enterpriser, laborer, 
and capitalist does not, however, make the functions 
indistinguishable . 

3. Opportunities for enterprise are most common 
where economic conditions are rapidly chang- 
ing. 

When the population of a city increases rapidly, oppor- 
tunities for new business enterprises emerge one after 
another. Profits are to be made by converting residential 
districts to business uses, and by opening up new residen- 
tial districts upon lands adjacent to the city. Increase in 
the number of large incomes in a city offers opportunity 
for businesses catering to the tastes of the rich. The in- 
creasing number of persons without means renders pos- 
sible the establishment of new manufacturing enterprises. 
A multitude of business opportunities arise when a new 
railway line is opened; when improvements are made in 
the means of producing or transmitting power; when the 
tastes of consumers undergo a marked change. 

War, however destructive to the general welfare, natu- 
rally opens an enormous number of opportunities for profit. 
Arms, niunitions and suppHes must be provided in vast 
quantities, whatever the cost. After the outbreak of the 
Great War immense profits were to be won by every 
enterpriser who could supply promptly the requirements 
of the belligerent nations. Existing factories were worked 
day and night, and new factories sprang up like mush- 
rooms. In the vicinity of the expanding war industries 
there was a great demand for housing, which offered 



ENTERPRISE AND BUSINESS PROFITS 285 

golden opportunities to owners of real estate and con- 
struction companies. All prices rose, and those who were 
in a position to buy stocks of goods and hold them won 
easy profits. War milHonaires multiplied in every country, 
neutral or belligerent, in spite of the general impoverish- 
ment produced by war. 

4. Enterprise often entails risks, hut this is not 
necessarily the case. 

An enterprising person, struck by the natural beauties 
of a mountain valley, decides to erect a summer hotel. 
He sinks his own capital and whatever capital he can 
borrow in erecting a building and in improving the 
grounds about it. The outcome may greatly exceed his 
expectations; throngs of patrons may seek admission to 
the hotel, enabhng him to fix his charges at a very high 
level; and even this may increase the popularity of his 
house, since high charges are often accepted as a guaranty 
of exclusiveness — the quaHty for which men are most 
willing to pay liberally. The event may, however, be far 
less favorable; a few straggling seekers for rest and quiet 
may be the only patrons secured, and these may hardly 
pay the running expenses of the business. In such a case 
the enterpriser loses not only his prospects of prosperity; 
he also loses, for all practical purposes, whatever capital 
he has embarked in the enterprise. 

Many enterprises, however, involve no risk. When a 
railway opens a new country, much of the land along the 
route is certain to rise in value, and those who are enter- 
prising enough to buy before the rise are assured of a sub- 
stantial return. The success of many enterprises involv- 
ing organization is capable of almost mathematical demon- 
stration. The exact measure of profit is usually uncer- 
tain, but that such an enterprise will afford the requisite 
minimum of return, may be predicted with certainty. 
The highest type of enterpriser is the one who places 



286 INTRODUCTION TO ECONOMICS 

nothing at stake until his calculations prove that there is 
practically no chance of loss. 

5. The existence of valuable opportunities in- 

volving no risk implies the fact that com- 
petition does not operate freely. 
The question naturally arises, how can opportunities in- 
volving no risk, or Httle risk, be found? If competition 
were keen, each opportunity would be seized upon as soon 
as the chances of gain seemed to outweigh the chances of 
loss. But competition seldom operates perfectly. Many 
men are conservative, and show a preference for the well- 
established routine. These men overlook most of the op- 
portunities within their reach. Other men see the oppor- 
tunities, but through lack of capital, business prestige, or 
managing ability, are not in a position to avail themselves 
of the opportunities that are presented. This is especially 
the case where the initial outlay required is a large one. 
You may know of an opportunity for the profitable invest- 
ment of $100,000; but if you have no capital of your own, 
you will find it almost impossible to induce other men 
even to listen to your project. The opportunity will 
probably wait for the man who has both enterprise and 
$100,000, or sufficient business prestige to induce other 
men to intrust him with their capital. 

6. The income which originates in enterprise 

is known as profit. It may be defined as a 
surplus remaining after costs, including 
interest on all capital and wages for all labor, 
have been met. 
In earlier chapters it has been shown that the returns 
to the average business enterprise must be sufficient to 
cover all costs of production, including under this head 
not only actual outlays, such as prices paid for materials, 
wages of hired labor, and interest on borrowed capital, 
but also ordinary returns on the capital owned by the 



ENTERPRISE AND BUSINESS PROFITS 287 

business man himself and reasonable wages for his labor. 
An exceptional opportunity is one that will do more than 
this. A surplus remains in the hands of the enterpriser 
after all costs have been met. This surplus is known in 
economics as "pure profit," or more simply, as ''profit." 
We must be careful to distinguish profit in this sense of 
the term from the income known as profit in the language 
of business. In the latter sense profit often includes inter- 
est on the enterpriser's capital and wages for his labor. 
Profit in the economic sense of the term is not essential to 
the continued operation of an estabhshed enterprise. 
Profit in the business sense of the term is a necessary in- 
come, since no one would remain long in a business un- 
less he obtained a return representing interest on his capi- 
tal and wages for his labor. 

7. The profits from an enterprise are commonly 
due to the fact that labor and capital in that 
enterprise are unusally productive, hut are • 
rewarded according to the standards generally 
prevailing. 
In any important industrial center the productivity of 
labor and of capital may at a given time vary from in- 
dustry to industry, while the wages of labor and interest 
on loanable capital vary Httle, if at all. We may arrange 
the different industries of such a center in a series, accord- 
ing to the degree of productivity of labor and capital in 
each one. Labor and capital will, as a rule, receive no 
higher rewards in any industry than in the one that stands 
lowest in the series. If we assume that in this least pro- 
ductive industry labor and capital receive all that they 
produce — and we cannot assume that they receive more 
than this — we see clearly that in all the industries higher 
in the series they must receive less than they produce. 
In the more productive industries the products of 
labor and capital afford a surplus above wages and 



288 INTRODUCTION TO ECONOMICS 

interest, which takes the form of a profit to the enter- 
priser. 

Let us suppose that the American pubHc, awakening to 
the significance of the ghastly record of railway accidents, 
forces through Congress a law requiring the railway com- 
panies to replace all remaining wooden passenger cars 
with cars of steel. The demand for steel cars would 
become enormous. The car-building companies, for a time, 
could sell their output at very high prices. The pro- 
ductivity of labor and capital in such estabhshments, 
measured in terms of price, would be abnormally high. 
But the wages of laborers engaged in building steel cars 
would be practically no higher than the wages of equally 
skilled laborers in any other branch of the iron and steel 
industries. There would accordingly be a surplus above 
costs, or a profit to the enterpriser. The car-building 
companies would pay no higher rate of interest on bor- 
rowed capital than any other manufacturing companies 
in the vicinity. A surplus originating in the abnormally 
high productivity of capital would thus be added to the 
profit from labor. 

In any industry the productivity of labor and capital 
may vary from estabHshment to establishment, although 
there may be no variation in the rates of wages paid. We 
may, if we like, arrange the estabhshments in a series, ac- 
cording to the degree of productivity of labor and capital, 
just as we did in the case of industries of varying produc- 
tivity. No higher wages or interest will be paid by any 
estabHshment than by the establishment working at the 
greatest disadvantage. As this establishment will pay to 
labor and capital no more than these agents produce, it 
follows that the better estabhshments will not need to 
pay out in wages and interest the whole product of labor 
and capital. A profit is left over for the enterpriser. 



ENTERPRISE AND BUSINESS PROFITS 289 

8. Profits, in some instances, are explained by the 
fact that labor and capital, though not more 
than normally productive, are secured at ab- 
normally low rates. 
Certain classes of laborers are in an exceptionally weak 
position, and may be compelled to accept wages decidedly 
lower than the prevailing rate. Immigrants from coun- 
tries with a different language and a lower standard of 
life must often accept conditions of employment that are 
exceedingly unfavorable. Where employers are of one 
race and employees of another, a set of institutions may 
develop which give the employer whatever remains of the 
product of labor above a mere minimum of subsistence. 
In some parts of the United States convicts and persons 
condemned to the workhouse are farmed out at rates that 
enable the employer of such labor to reap large profits. 
Women employed under the sweating system, and, to a 
less extent, women employed in factories and shops, are 
often paid less than their labor is really worth, according 
to competitive standards. In the history of every indus- 
trial country, instances have appeared of large profits 
founded upon the exploitation of child labor. 

A similar exploitation of capital sometimes occurs. Not 
many years ago, in some of our states, persons intrusted 
with public funds habitually employed such funds for 
their own advantage. Such a course of action, even 
when not unlawful, was generally disapproved, and hence 
was kept secret, so far as possible. Loans of such funds 
were made at rates low enough to purchase silence from 
the borrower, who, accordingly, was placed in a position 
where he could make large profits. Trustees having little 
interest in their wards have been known to lend the funds 
intrusted to them at abnormally low rates. Instances of 
this kind are by no means so rare as they are generally 
supposed to be; but recognition of this fact must not 



290 INTRODUCTION TO ECONOMICS 

lead us to the view that profits are normally the result 
of conscienceless exploitation. 

9. Profits may arise from the transportation of 
labor or capital from regions of low returns 
to regions of high returns, under contracts 
in which rewards are based upon standards 
prevailing in the regions of low productivity. 
Let us suppose that employers of large numbers of un- 
skilled laborers in the United States were free to send 
agents to Europe, or the Orient, to obtain a supply of 
labor. What the agent would offer for, say, two years' 
labor would be the local rate of wages for that period of 
time together with such a premium as might be necessary 
to overcome the reluctance of laborers to leave their na- 
tive land. The cost of labor in this case would be deter- 
mined chiefly by the standards of productivity prevailing 
in the countries from which the laborers were imported, 
while the value of the labor to the enterpriser would be 
determined by American conditions of productivity. By 
virtue of the labor contract the employer would thus be 
enabled to retain for himself a part of the product of the 
labor. 

It is obvious that the possibility of obtaining a profit of 
this nature depends in large measure upon the character 
of the laws relating to labor contracts. If the enterpriser 
cannot enforce the contract by law the laborers whom he 
has imported may desert him before their services have 
yielded adequate compensation for the cost of bringing 
them to the country. In the United States to-day, not 
only would such a contract be unenforcible, but the im- 
portation of laborers from foreign countries under such 
contracts is a punishable offense. This was not formerly 
the case, and one of the important sources of profits in 
early American economic history was of the character 
that has been described. In many parts of the world, 



ENTERPRISE AND BUSINESS PROFITS 291 

especially in the tropics, the contract labor system is still 
widely used. There are companies which make it their 
sole business to supply enterprisers with contract laborers 
from China and India. Such companies derive their profit 
from the product of the laborers, part of which is made 
over to the company by the enterpriser who employs the 
laborers. 

We need not here consider the reasons that have led to 
the general condemnation of enterprise that relies for its 
profits on contract labor. What we are more immediately 
concerned with is- the possible extent of profits of this na- 
ture. Let us suppose that the Chinese coolie in his own 
home can obtain an annual wage of $50, while his ser- 
vices on a Spanish-American plantation or other enter- 
prise are worth $250 per annum. Allowing $150 for 
bringing the laborer from China and for his return, and 
$50 a year to overcome his reluctance to leave his native 
land, there would remain, on a two-year labor contract, 
a profit of $150 to the enterpriser, if he imports the labor 
directly, or to be divided between the enterpriser and the 
coolie labor company, if the latter acts as intermediary. 
We may apply the same reasoning to the case of profits 
arising from the transfer of capital from regions where its 
productivity is low to regions where its productivity is 
relatively high. A mortgage loan company may borrow 
capital in New York at five per cent interest and loan it 
in Texas at seven per cent. The loan company thus re- 
ceives a profit of two per cent. How is this profit pro- 
duced? Clearly it is a part of the product of the capital 
set at work in Texas. 

10. Profits may arise when commodities which sell 
at prices covering costs in high wage-stand- 
ard regions are worked up in regions having 
a low wage-standard. 
The prices charged by American bookbinders for the 
binding of books are based upon the cost of labor in this 



292 INTRODUCTION TO ECONOMICS 

country, which exceeds the cost of equally efficient labor 
in foreign countries. There are men who ship books from 
the United States to Paris to have them bound, as the 
cost of transportation is not high enough to equal the 
saving in wages. The net saving represents a profit to 
the enterpriser. There are metropolitan publishing houses 
that have printing done in small towns, where rates of 
wages for printer's labor are less than in the large cities. 
The profits of Southern cotton manufacturers were for a 
long time dependent upon the fact that, while the prices 
they received for their products were held at a level suffi- 
cient to cover costs in New England, the wage level in 
the South was lower than that of New England. Great 
profits were gained by Japanese cotton manufacturers by 
virtue of the fact that while the prices of cotton goods in 
the Orient had to be sufficient to cover the high labor 
costs in America and England, labor could be had in Japan 
at very low wages. 

Profits may also arise through transferring an industry 
from a region of dear coal to a region of cheap coal. If a 
commodity is expensive to transport, profits may be made 
by removing the industry producing it to a point near the 
centers of consumption; if the materials entering into 
the production of a commodity are exceedingly bulky, 
profits may be made by removing the industry to points 
near the source of supply of materials. With changes in 
the technique of transportation and in charges for carry- 
ing goods, there are changes in the relative advantages 
of different producing centers; and those enterprisers who 
can adapt themselves quickly to these changes are able to 
gain profits. 



ENTERPRISE AND BUSINESS PROFITS 293 

11. Under certain business conditions, enter- 
prisers as a class may reap profits, owing 
to the fact that the rates of wages and interest 
are slow to change. 
In times of business prosperity it often happens that 
the prices of ahnost all commodities rise; or, what 
amounts to the same thing, the products of labor and 
capital, measured in terms of price, increase. For a time 
enterprisers fear that the rise in prices is a merely tem- 
porary phenomenon, to be followed, perhaps, by a fall of 
prices to a level lower than that existing before the rise. 
So long as enterprisers maintain this attitude, they natu- 
rally refrain from enlarging their businesses. No enter- 
priser attempts to entice away the workmen in the em- 
ploy of other enterprisers, as he would do if he believed 
that the high level of prices would be maintained, nor 
does he increase his demands upon the fund of loanable 
capital. There is accordingly no reason why wages and 
interest should rise. The effect of the rise of prices is 
thus to increase the price of the products of labor and 
capital without increasing the cost of labor or of the use 
of capital. If before the rise in prices labor and capital 
received the whole value of their products, it is obvious 
that they receive less than this after the rise. A part of 
the product of labor and of capital remains in the hands 
of the enterprisers as a profit. 

During the Great War, while wages increased, they 
did not increase so rapidly as the prices of the products 
of labor. In all American employments, wages represented 
on the average 55.6 per cent of the value output in 1913. 
In 1914 the share of labor was 54.7; in 1915, 53.6; in 
1916, 51.9; in 1917, 51.6; in 1918, 54. A greater part of 
the product of industry must therefore have taken the 
forms of interest and profits. As interest responds very 
slowly to changes in economic conditions, we may safely 



294 INTRODUCTION TO ECONOMICS 

assume that during those years there was a substantial 
increase in the aggregate profits of enterprisers. 

12. Profits are, in most instances, a temporary 
form of income. 

The sources of profit that have been described have one 
characteristic in common: they cannot flow for a very 
long period of time. An importer of coolie labor may, 
for a time, make large profits; but if he does so, other 
importers appear, and either force up the price of this 
kind of labor at its source or depress the value of the 
services of coolie labor in the importing country. Sweat- 
shop contractors may make large initial profits out of 
underpaid labor; but in the end the number of contrac- 
tors increases, and this either raises the wages paid to this 
kind of labor, or, what is more commonly the case, re- 
duces the prices that are paid to contractors. Profits 
depending upon local cheapness of labor eventually dis- 
appear on account of increase in competition for such labor 
and rise in its price, except in cases where the supply of 
labor is practically unlimited, as in the Orient. In these 
cases the industry must eventually develop to such an 
extent as to create a large increase in the product, with 
a consequent reduction in its price; and thus, in the end, 
a level of prices of finished products is established which 
corresponds with the lower cost of labor, and leaves no 
margin for profits. If profits depend upon superiority of 
methods, these methods, in time, are universally adopted, 
and prices fall accordingly. If profits depend upon in- 
dustrial misadjustments that leave some industries under- 
supplied with labor and capital, they are eventually elimi- 
nated by migration of labor and capital from the fields 
that are oversupplied to those that are under supplied. 
The general profits that attend business prosperity are 
wiped out by readjustments in the prices of products and 
in wages and interest. 



ENTERPRISE AND BUSINESS PROFITS 295 

A particular enterpriser may, indeed, obtain a contin- 
uous income from profits. When he finds that one source 
of profit is running dry, he searches out another. This 
impHes a rapidly developing state of industry, such as 
one finds in new countries like the United States. In this 
country it is not difficult to find instances of men who 
have enriched themslves now from one source of profit, 
now from another. 

13. Profits dependent upon the various forms of 
monopoly may display a high degree of 
permanence. 

One of the most important sources of profit is the intro- 
duction of new and more fruitful methods of production. 
So long as such a method is confined to one out of a num- 
ber of competing estabhshments, prices remain at a level 
which covers cost of production in the establishments 
which do not employ the new method. If the new 
method of production is really an innovation in industry, 
and if it is of such a nature as to admit of definite 
description — as, for example, a mechanical device for 
saving labor — the person who invented it may take out 
a patent, which will assure to him the exclusive right of 
using it for a period of time — seventeen years, in the 
United States. During this period he may continue to 
enjoy the profits arising from the use of the method. 
He may, of course, sell the right of use to other persons, 
in which case he makes labor and capital more produc- 
tive in the establishments buying the right, reserving for 
himself, in the shape of payments for the use of the 
patent, a part of the product of these agents of production. 

Somewhat analogous to the profits arising from a pa- 
tent are the profits arising from the use of a trade-mark 
or from the ''good- will" of a concern. A certain brand of 
soap has, let us say, a reputation for purity, established 
by long years of honest business. Another soap bearing 



296 INTRODUCTION TO ECONOMICS 

another name may be just as pure; but the consumer 
has no adequate means of determining qualities, and 
therefore prefers the brand which he has always believed 
to be good. It is evident that the manufacturers enjoy- 
ing such a firm hold on the popular favor can charge 
somewhat higher prices for goods of a given grade than 
can manufacturers who have their reputation yet to 
establish. So a merchant who has established a reputa- 
tion for upright dealing, or who has succeeded in attract- 
ing to himself the patronage of the wealthier classes of 
a city, can charge somewhat more than can his less for- 
tunate competitors. The public esteem which an enter- 
priser enjoys — the good-will of the business — is some- 
times only an insignificant source of profits. Sometimes, 
however, it is an exceedingly important source. In 
many cases the good-will of a manufacturing or mercan- 
tile establishment is worth more than its aggregate 
tangible assets. 

The profits arising from patented processes and from 
the good-will of an establishment fall under the general 
head of monopoly profits. The surplus returns to an 
ordinary monopoly may be described in the same way. 
Let us suppose that all the manufacturers of tin plate 
agree to reduce output twenty per cent in order to force 
up prices. If the various producers can be held to their 
agreements, and if new producers can be kept from 
entering the field, there is no reason why every enter- 
priser in the business should not enjoy a permanent 
profit. In the chapter on monopoly price we saw how 
this can be done. What the monopolists do, from the 
point of view of distribution, is this: A group of allied 
enterprisers throw a fence, as it were, around a particu- 
lar field of industry. They limit the amount of labor 
and capital admitted to the field, so that the produc- 
tivity of these agents remains higher than in the un- 



ENTERPRISE AND BUSINESS PROFITS 297 

monopolized fields. Consequently, there remains in the 
hands of the monopolistic enterprisers a surplus or profit. 

14. Monopoly profits may he capitalized in the 
same way as other permanent incomes 
from property. 

We saw in the last chapter how it is possible to arrive 
at the value of a capital good, such as a field, by capital- 
izing the income at the current rate of interest. Perma- 
nent profits may be reduced to a capital value in the 
same way. If the profit from a monopoly is $100,000 
a year, and if there is good reason for believing that it 
will continue to be the same from year to year, the 
monopoly itself is worth as much as a sum of capital 
that will yield $100,000 interest per annum. If capital 
generally yields five per cent, the monopoly is worth 
$2,000,000. If the enterprisers having such a monopoly 
were to sell out their interests, they would demand that 
sum over and above full payment for all the buildings, 
machinery, and other tangible assets of their business. 
The same thing is true of the profits arising from the 
good-will of a business. These profits will be capitalized, 
and the buyer of the business will have to add the capital 
value of the profits to the value of the tangible capital goods. 

The value of a patent is found in a similar manner. 
The only difference is that the profits from this source 
cease upon the expiry of the patent. What the buyer 
pays for is the right to a certain estimated income for a 
definite number of years. If the annual income is esti- 
mated at $5000 a year, and the patent has ten years to 
run, the simplest way of arriving at the value of the 
patent is to find the present value of each year's income, 
and add these sums together. If the current rate of in- 
terest is four per cent, the present value of $5000 due in 
one year is obviously equal to a sum which, plus interest 
for a year, will amount to $5000. That sum is about 



298 INTRODUCTION TO ECONOMICS 



507. $5000 to fall due two years hence is worth a 
present sum which together with compound interest at 
four per cent will in two years amount to $5000 — $4625. 
By a similar process — ^^ known as discounting — the value 
of each year's income may be ascertained, and by addi- 
tion, the present value of the patent is established. 

15. Profits usually play an important part in 
promoting economic progress and in direct- 
ing the distribution of the productive re- 
sources of society. 

All profits, whether monopolistic or not, are, from the 
point of view of distribution, a part of the product of 
labor and capital which various circumstances enable the 
enterpriser to retain for himself. It may therefore ap- 
pear, at first thought, that the existence of profits is 
evidence of injustice in the distribution of wealth. 

Upon reflection, however, we see that this is not uni- 
versally true. Profit in many cases plays an important 
part in stimulating economic progress; in many other 
cases the existence of profit serves as a means of distrib- 
uting the agents of production in such a way as best 
subserves the interests of society. An income that must 
exist if society is to be progressive and if the best dis- 
position is to be made of its productive resources can 
hardly be regarded as unjustifiable. 

It is the hope of profits that induces the enterpriser to 
devise improved methods of production, or to adopt im- 
provements devised by others. In doing this the enter- 
priser increases the productivity of labor and capital, 
reserving for himself, as long as ho can, the benefits of 
this increased productivity. But sooner or later the new 
method finds general application in the industry, and the 
enterprisers are forced to yield up the benefits arising 
from it to labor and capital, in the form of increased 
wages and interest, or to the consumer of commodities 



ENTERPRISE AND BUSINESS PROFITS 299 

in the form of lower prices. In the latter case all laborers 
and capitalists gain by an increase in the purchasing 
power of their incomes. 

When profits arise from a general increase in the de- 
mand for a commodity, the ethical title of the enter- 
priser to the income is not quite so clear. But such an 
increase in demand shows that the amount of labor and 
capital devoted to the industry affected by the increased 
demand should be increased. Under the competitive sys- 
tem this result can be brought about only through the 
action of enterprisers. Now, if enterprisers received no 
profit from enlarging old works and establishing new ones, 
why should they trouble themselves with doing this? If, 
on the other hand, they may for a time keep for them- 
selves as a profit a part of the price of their products, they 
will naturally endeavor to enlarge their works as quickly 
as possible. When at last as much labor and capital is 
devoted to the industry as is socially expedient, profits 
cease through rise in wages and interest or through fall 
in prices. 

Of the forms of profit that are classed as monopolistic, 
those arising from patented inventions and from good- 
will need no defense. The former is the reward for one 
of the most important services to society. The inventor 
can never get for his services, at any time, more than 
they are worth to society; at the expiry of the patent 
the invention becomes the common possession of all. 
The profits arising from good-will, in the literal sense 
of the term, are a reward for honorable business deaHng, 
and can be retained only so long as the enterpriser is 
worthy of them. 

16. The profits of an ordinary monopoly cannot 
he ethically justified. 

The profits of an ordinary monopoly, so far as they 
are true monopoly profits, stand on an entirely different 



300 INTRODUCTION TO ECONOMICS 

footing. The productivity of labor and capital in the 
field controlled by the monopoly is rendered abnormally 
high, not merely through superior organization and com- 
bination of these factors in production, but largely 
through the maintenance of an artificial scarcity of them, 
which is directly opposed to the interests of society. 
While the action of any one out of a number of competing 
enterprisers, each striving to increase his own profit, usu- 
ally operates to increase the aggregate wealth produced 
by society, the action of a combination of enterprisers 
striving to secure a monopoly profit operates to reduce 
the aggregate wealth production of society. Through his 
anti-social conduct the monopolistic enterpriser receives 
a permanent profit, the fruits of other men's labor and 
capital. The enterpriser who carries on business under 
conditions of competition receives, as a reward for his 
important services to society, only a temporary profit. 

It appears, therefore, that the elimination of monopoly 
profit through legislative action, if possible, is eminently 
desirable. It is, however, to be borne in mind that this 
cannot always be done without injustice. We have seen 
that monopoly profit, being permanent, may be capital- 
ized. If a combination of manufacturing enterprises 
makes possible a monopoly profit of $100,000, the sell- 
ing value of the combined enterprise — or of the capital 
stock representing it — is increased by the capital value 
of an income of $100,000. Now, the original promoters 
of the monopoly do not continue to own it forever. 
Some of the stock in it may pass to their heirs; some of 
it may be sold to persons who do not know that a great 
part of its value is merely the capitalization of a wrong- 
ful monopoly profit. If, then, the profit of the monopoly 
is eliminated, the latter class of persons find themselves 
deprived of an income the right to which they purchased 
in good faith as an income from capital. 



ENTERPRISE AND BUSINESS PROFITS 301 

17. Profits, in time of economic emergency, may 
lose all practical relation to productive 
efficiency and become in effect a form of 
of exploitation. Such a degenerate form of 
profit is popularly known as profiteering. 
It has already been indicated that opportunities for 
profit become very common at times of great economic 
changes or readjustments, such as take place, for example, 
during a great war. Economically, war represents a tre- 
mendous shift in the character of the products of indus- 
try in demand. Plowshares must be beaten into swords. 
The sums which private individuals would have spent 
for all the miscellaneous commodities of peace, are taken 
from them by the government by means of taxation or 
through the flotation of loans and lavished upon arms, 
munitions and other military supplies. With an army 
in the field the government must have these things, and 
usually in vastly greater volume than can be supplied 
by existing facilities of production. Factories that had 
been equipped to produce locomotives must be con- 
verted to the production of field guns. Watch factories 
must be converted to the making of time fuses. Great 
difficulties present themselves in this process of conver- 
sion. Old machinery must be torn out and new ma- 
chinery installed. The working personnel must be trained 
to new kinds of work. The government might take over 
the factories and convert them to such uses, or erect new 
ones, and produce the goods it requires. But in time of 
war a government usually has all its abilities severely 
strained in organizing armies, managing transport, etc. 
Therefore it relies upon private enterprise to provide 
war material. This means that a price must be offered 
that will tempt enterprise and stimulate maximum efforts. 
That is likely to be a generous price, offering liberal 
profits. 



302 INTRODUCTION TO ECONOMICS 

Within limits, private enterprise is justified in demand- 
ing the profits, because there are serious risks of loss in- 
volved. But the limits of reasonable profits are easily 
exceeded. The purchasing agents of a government at 
war are little concerned over prices. They must get 
the supplies; few questions will ever be raised as to the 
prices. Enterprisers are thus often in a position to charge 
about what they please, and many of them take full ad- 
vantage of their position. During the Great War such 
abuses were common in every belligerent country. Nat- 
urally, there was great popular hostility to men who 
thus enriched themselves at a time when the people as 
a whole were meeting the heavy sacrifices of war. 

In supplying the civil population, also, numerous op- 
portunities for excessive profits arise during war time. 
There may be wheat and meat and sugar enough for 
all ordinary demands, but a panic may arise among con- 
sumers which leads to excessive bidding and a rise in 
prices for which there is no real justification. The public, 
too, gets accustomed to an order of things in which every- 
thing goes up in price. Merchants find it easy to mark 
up their prices, and thus make large profits. Rather 
late in this period of rising prices, partly because civil 
construction ceases in war time, rents go up, sometimes 
to exorbitant levels. If these successive price inflations 
resulted in an important stimulus to production they 
might be accepted by the public with philosophy. In 
many cases, however, they result in no increase in pro- 
duction at all, and seldom is the stimulus sufficient to 
compensate the public for the burdens thrust upon it. 

When the evil of excessive profits or ''profiteering" 
becomes intolerable, the government usually makes an 
effort to remove it by fixing prices. But the adminis- 
tration of price fixing is very difficult. The methods of 
evasion are numerous and subtle, and no government 



ENTERPRISE AND BUSINESS PROFITS 303 

has yet found an adequate remedy for the disease of 
profiteering. 

18. Summary. 

In a progressive society exceptional opportunities for 
the employment of labor and capital are continually pre- 
senting themselves. The act of seizing upon such oppor- 
tunities is known as enterprise; the income arising from 
enterprise is pure profit. The existence of profitable op- 
portunities is evidence of the fact that competition does 
not operate freely. 

From the point of view of distribution profit is an in- 
come created by labor and capital, but retained by the 
enterpriser. When labor and capital are abnormally pro- 
ductive, but are paid at normal rates, a surplus remains 
for profit; when labor and capital are normally produc- 
tive, but are paid at abnormally low rates,, a similar 
surplus appears. The importation of labor and capital 
from regions of low productivity to regions of high 
productivity, with the maintenance, in the latter regions, 
of the standards of pay established in the former regions, 
is one source of profit; the transfer of an industry from 
a region in which standards of pay are high to a region 
where such standards are low is another source of profit. 

As a rule, profit is a temporary form of income. Mo- 
nopoly, in its various forms, gives to profit a fair degree 
of permanence. Monopoly profit is therefore capitalized 
like any other form of permanent income. 

Since profit is an income produced by the labor and 
capital of one set of men and enjoyed by another set of 
men, it appears to demand an ethical justification. 
Competitive profits may be defended on the ground that 
they serve as an incentive to improvement, and help 
to adjust the supply of each commodity to the demand 
for it. Such forms of monopoly profit as the royalties 
of an inventor and the receipts from the good-will of a 



304 INTRODUCTION TO ECONOMICS 

business are easily defended. The profits of an ordinary 
monopoly cannot be defended, ethically; their continued 
existence depends upon a calculated misadjustment of 
demand and supply. In war time opportunities for profit 
are multiplied and lead to a condition of profiteering for 
which no satisfactory remedy has been found. 



CHAPTER XVI 
MONEY 

1. Money is anything that practically all men 
are ready to accept in exchange for their 
goods, with the expectation of employing it 
in the acquisition of other goods. 
In the foregoing chapters frequent use has been made 
of the term price, which of course impKes the term 
money, since price is nothing but exchange value, ex- 
pressed in terms of money. It has been tacitly assumed 
that money is in general use and that its value remains 
constant, price fluctuations being due to changes in the 
conditions of production or consumption of other things. 
The latter assumption, as every one familiar with recent 
discussions of economic policy is aware, cannot pass un- 
challenged. The value of money, Hke the value of all 
other things, is subject to continual fluctuations, and 
these fluctuations give rise to some of the most important 
problems of practical economics. 

We may profitably begin this part of our study by con- 
sidering what it is that the plain man regards as money. 
Anything that is accepted by practically every one in ex- 
change for his goods or services, with the sole intention of 
exchanging it ultimately for other goods or services, is 
popularly regarded as money. This view, which is also 
that of many of the ablest writers on money, we may safely 
adopt as our own. Under different conditions of economic 
development, different concrete things have served as 
money, — shells, beads and other ornaments, bits of metal 

30s 



3o6 INTRODUCTION TO ECONOMICS 

coined or uncoined, and even such commodities as cattle 
and furs. With the evolution of trade, a corresponding 
evolution of money has taken place, and those forms of 
money which were fitted for use when trade was merely an 
incidental part of economic life have given way to forms 
of money adapted to a complex system of commerce. 
2. The origin of money is to he sought in a gradual 
and unconscious evolution in which certain ar- 
ticles of direct use came to he more and more 
frequently accepted in exchange merely as a 
means of acquiring other articles of direct use. 
The origin of money antedates all historical records. 
Nevertheless, we know enough about the life of primitive 
man to construct a plausible view of the circumstances 
under which money must have come into existence. In 
the earlier stages of human evolution exchange, at least 
in the modern sense of the term, was unknown; hence, of 
course, money could not have existed. When it first be- 
came customary to make exchanges, goods were doubtless 
bartered directly for goods, as is sometimes the case even 
to-day. Certain articles, however, were more frequently 
the objects of exchange than others, as, for example, 
strings of seashells, articles of copper, silver, and gold 
suitable for personal adornment. Such articles, unlike the 
common necessaries of existence, could not be produced 
by any one desiring them. Not being essential to life, 
they would naturally be sacrificed by their possessors in 
time of need. The desire for such articles, on the other 
hand, could not be readily satiated. We can easily see, 
therefore, why articles of this nature should have been 
among the earliest to be freely purchased and sold. We 
can also see why persons having ordinary commodities to 
dispose of should have been willing to accept such articles 
with at least a half-intention of exchanging them later for 
other commodities. Men desiring such articles, and will- 



MONEY 307 

ing to make sacrifices to obtain them, could easily be 
found. 

Just at what point articles of personal adornment, as, 
for example, silver bracelets, ceased to be ordinary com- 
modities and became money it would of course be impossi- 
ble to say. At any stage in this development some men 
may have accepted them solely with a view to a further 
exchange, while others may have accepted them primarily 
with a view to further exchange, yet with the alternative 
of personal use before them ; and still others, with no inten- 
tion of exchanging them for something else. To the first 
class of persons, the bracelets would have been money; to 
the second, neither money nor ordinary commodities but 
something half way between; to the last class they would 
have been merely ordinary commodities. If the last two 
classes were relatively insignificant, the bracelets would 
properly have been called money. We do not hesitate to 
call nickels and dimes money, although certain of the abo- 
riginal inhabitants of the United States perforate all they 
can obtain and hang them in strings from their ears. 

3. The functions of money are (i) that of medium of y 
exchange; (2) that of store of purchasing 
power; (3) that of measure of value; and (4) 
that of standard of deferred payments. 

When a farmer exchanges a load of wheat for money, 
and immediately exchanges the money for household sup- 
plies, the money so far as he is concerned serves merely 
as means for exchanging the wheat for household supplies. 
If the farmer does not immediately purchase the supplies, 
but keeps the money in his strong box against future 
needs, we may say that the money serves as a convenient 
means of keeping the purchasing power originally repre- 
sented by the wheat through a period of time, or as a store 
of purchasing power. If the local dealer is at once a grain 
buyer and a dealer in household supplies, no money may 



3o8 INTRODUCTION TO ECONOMICS 

actually be used in effecting the exchange. The value of 
the grain is estimated in terms of money, as is also the 
value of the household suppHes, and the one quantity of 
money value is set against the other. In this case money 
is used solely as a measure of value. If the farmer delivers 
his wheat, but ''trusts" the dealer with its value the future 
obligation of the dealer to the farmer is reduced to definite- 
ness in terms of money. The farmer is credited, not with 
forty bushels of wheat, but, we will say, with $50. In this 
way money serves as a "standard of deferred payments." 
The primary function of money is that of medium of 
exchange, and from it are derived the other three functions. 
Money serves as a store of purchasing power because of 
its universal acceptability in exchange. It serves as a 
measure of value because men are constantly weighing 
the value of other things against that of money. And 
for the same reason it serves as a standard of deferred 
payments. If you promise to deliver to me one thousand 
bushels of wheat a year hence, I have no very definite 
idea as to the sum of value I am to receive. If you prom- 
ise to deliver to me $1000 a year hence, I have a definite 
idea as to the sum. 

4. Anything serving as money should present in a 
high degree the qualities of uniformity , stability 
of value, and adaptability to transactions of 
varying magnitude. 
In the early modern commercial centers traders were 
always seriously handicapped by the great variety of coins 
used as money. In every business transaction it was 
necessary to examine the money offered in payment almost 
as carefully as the quality of the articles offered for sale. 
In many cases gold and silver coins passed by weight; 
but even in such cases there was always some question 
as to the real value of the money, as the coins of different 
countries were of different degrees of fineness. It is hard 



MONEY 309 

to exaggerate the advantages presented by a monetary 
system like that of the United States of to-day, in which 
one dollar represents the same value as any other. 

Hardly less important than uniformity is stability of 
value. If money is to serve as a store of purchasing power, 
its value must not be subject to rapid fluctuations. If it is 
to serve as a standard of deferred payments, stability of 
value is of extreme importance. Imagine the inconvenience 
of a standard fluctuating in value as widely as do most of 
the commodities of common use. A man borrowing money 
for a six-months period might find himself, at the end of 
the period, compelled to pay back twice as great a sum of 
value as he borrowed; or he might escape with paying 
half as great a sum. With such a fluctuating standard all 
contracts involving future payments of money would be- 
come highly speculative. 

What really happens when the value of money fluctuates 
widely has been amply exhibited in the economic history 
of Central Europe since the outbreak of the Great War in 
1914. The German mark, worth 23.8 cents in 1914, had 
fallen to one and three quarters cents in February, 192 1, 
and one half a cent in February, 1922. The Austrian crown 
worth 20.3 cents in 19 14, was worth a quarter of a cent in 
February, 192 1, and four hundredths of a cent in February, 
1922. Any long term loans contracted before the war and 
due in 1922 could be paid off with a sum representing, in 
Germany, one forty-seventh, and in Austria, one five 
hundredth of the value originally loaned. With a ten 
dollar bill an Austrian house owner could extinguish a 
five thousand dollar mortgage contracted before the war. 
And even one year loans, contracted at the beginning of 
192 1, could be paid off, in Germany, with money worth 
one-third, in Austria with money worth one-sixth of the 
sum loaned. 

For an advanced commercial nation, adaptability of 



3IO INTRODUCTION TO ECONOMICS 

money forms to transactions of varying magnitude is of 
great importance. In the rural districts of China, where 
trade is chiefly local and the articles of trade of low value, 
coins of one kind, and these of very low value, meet practi- 
cally all needs. • In a country like our own, with the greatest 
variety of business transactions to be performed through 
the medium of money, a wide variety of forms of money is 
required. For the smallest transactions it is necessary to 
have coins of a value which is low, relatively to bulk, as 
bronze cents, nickel five-cent pieces. For slightly larger 
transactions, coins of silver, which represent a greater 
value per unit of bulk, are more convenient. For transac- 
tions involving still greater values, gold coins are better 
adapted than silver; for the largest cash payments, paper 
money, which may be of any denomination, is the most 
convenient of all. How important is this variety in forms 
of money will be understood by any one who happens to be 
engaged in business in a town where at times the supply 
of small coins is not sufficient to meet the needs of petty 
trade. 

5. Uniformity in the medium of exchange depends — 
upon effective governmental regulation. 

From very early times it has been recognized that the 
coinage of money is a business of such great public im- 
portance that it cannot be left to unregulated private enter- 
prise. The private coinage of gold and silver has indeed 
sometimes been tolerated. In the United States as late 
as i860 privately coined gold was to be found in circulation. 
But experience showed then, as it had often shown in 
earlier periods of the world's history, that private coinage 
results in serious evils. Coins that circulated as of equal 
value differed as much as ten per cent in their gold content. 
Those who were least able to judge the probable value of 
such privately issued coins were likely to be cheated in 
trade with those who were better able to judge the value 



MONEY 311 

of these coins. Because of such evils the issue of coins by 
private individuals has been prohibited by law. All coins 
are issued directly by government, and measures are 
taken by every well-regulated state to insure uniformity of 
value of money thus issued. 

6. The function of government in issuing money may 
be (i) to stamp the weight and fineness of metal 
in a coin; or (2) in a restricted sense, to deter- 
mine the value of money regardless of the 
material composing it. 
The government may hold its mints open to private 
owners of precious metal, coining on their account all the 
metal they offer for coinage. Thus any holder of gold 
bullion can take it to the Unites States mints and have it 
made into coins. In such case it cannot be said that the 
government determines the value of the coins issued. If 
there is a large production of gold, there is likely to be an 
increase in the amount of gold taken to the mints for 
coinage, and, as we shall see later, a tendency toward a 
decline in the value of the coins. The government assures 
the recipient of a gold coin that it contains the requisite 
amount of pure gold; practically it assures him of nothing 
more. 

When a metal is freely coined on individual account, 
there can be no perceptible difference in value between a 
given amount of the metal in the form of coin and an 
equal amount in the form of bullion. In the United States 
an ounce of uncoined gold is worth just as much as an 
ounce of gold coined. If for any reason gold in the form 
of coins should become more valuable than gold in the 
form of bullion, more bullion would be taken to the mints, 
and the difference in value would disappear. If uncoined 
gold became more valuable than gold in coins, coins would 
be melted down, and again the difference would disappear. 
A government may accept for coinage on individual ac- 



312 INTRODUCTION TO ECONOMICS 

count either gold or silver, or both metals. When gold 
alone is freely coined on individual account, the monetary 
system of a country is said to be based upon gold monomet- 
allism. When both gold and silver are freely accepted for 
coinage, the monetary system is based upon bimetallism. 
The bimetallic system was generally employed in modern 
times until the nineteenth century. Early in that century 
Great Britain adopted gold monometallism, and in the latter 
half of the century the same system was adopted by all 
other important commercial nations. 

When a monetary system is based upon gold freely coined 
by government on individual account, the needs of trade 
require the presence of money composed of other materials, 
such as silver, nickel, bronze, and paper. The value of 
such forms of money is said to be determined by govern- 
ment, since it bears no fixed relation to that of the material 
from which it is made, as is the case with the money made 
from a metal freely coined. As a fact, the government 
issuing such money usually adopts measures designed to 
maintain a fixed relation between its value and that of gold. 
The government of the United States regulates its currency 
in such a way that a five-dollar bill, or five silver dollars, or 
five hundred bronze cents are always equal in value to a 
five-dollar gold piece. Gold coin, which serves as a stand- 
ard, may rise or fall in value; all other forms of money 
rise or fall with it. All the non-standard forms of money 
are said to be maintained at a parity with the standard 
form. 

7. The only practical way of maintaining all the 
forms of money at a parity is through provision 
for the exchange of any form for the others at the 
option of the holder. 

If a government issues a limited amount of paper money 
and makes it legal tender, that is, receivable at its face 
value in payment of all debts, public and private, such 



MONEY 



3^3 



money may circulate at par, with no further provision for 
regulating its value. If I am offered a piece of paper 
which I am certain will be equivalent to $io in gold in the 
payment of taxes, or in the payment of my debts to other 
persons, there is no reason why I should not accept it as 
readily as $io in gold. 

If much of this kind of money is issued, however, every 
one may hesitate to accept it in lieu of gold. Dealers may 
refuse to accept it in exchange for their goods; accordingly, 
it may depreciate in value in spite of the fact that it is re- 
ceivable at par in payment of pubHc dues and existing 
debts. / 

To make certain that non-standard forms of money shall 
not fall below their face value in gold, it is customary for 
governments to make provision for redeeming them in gold 
on demand. In the monetary system of the United States 
are to be found coins of gold, silver, nickel, and bronze, as 
well as paper money. Part of the paper money consists of 
gold and silver certificates; a small part of it, of treasury 
notes, issued in payment for silver bullion; part of it of 
''greenbacks" — promissory notes of the government, a leg- 
acy of the Civil War. All these forms of money are main- 
tained at an absolute parity by the government. The gold 
' certificates cannot fall below the value of gold coin, because 
for every dollar of such certificates there is a dollar's worth 
of gold coin or bullion in the United States Treasury, pay- 
able to the certificate holder on demand. The silver cer- 
tificates are likewise secured in value by treasury holdings 
of silver. In the war emergency some part of the silver 
holdings of the Treasury were sold to supply the demands 
of oriental countries. This left a part of the outstanding 
stock of silver certificates uncovered by actual silver, a 
point of no especial consequence, since no one desires to 
exchange silver certificates for silver in any notable quantity. 
But the act authorizing the sale of the silver also provided 



314 INTRODUCTION TO ECONOMICS 

that after the emergency was over the silver hoard should 
be restored by new purchases. It is a part of the settled 
policy of the United States to maintain the silver dollars 
at a parity with gold; and although no specific provision 
is made by law for the exchange of silver dollars for gold 
at the treasury, the privilege of making such an exchange 
would be accorded the holder of silver dollars if the latter 
showed any tendency to depreciate. A reserve of $150,- 
000,000 in gold is held by the treasury for the purpose of 
redeeming any greenbacks that may be presented for re- 
demption. Any one who desires may exchange the lesser 
silver, nickel, and copper coins for gold by presenting them 
in suitable quantities at the treasury. 

8. // a government fails to maintain all its forms of 
money at a parity, those forms that become 
depreciated tend to drive those that are not 
depreciated from circulation. This principle 
is known as Gre sham's law. 
Let us suppose that the government of the United 
States issues a large volume of paper money, and makes 
no adequate provision for exchanging gold for such paper 
at the option of the holder. The value of this money 
would be very likely to depreciate, in terms of gold. After 
depreciation, every person who has payments to make in 
which the form of money is not specified, naturally uses 
whatever paper money he has in his possession, and retains 
his gold. If he has nothing but gold in the first instance, 
he exchanges it for paper, since he can get more than $100 
in paper for $100 in gold, and then makes his payments in 
paper money. Thus gold ceases to pass freely from hand 
to hand; if it is used at all, it is as a commodity, valued 
in terms of paper money. Thus the paper money issued by 
the United States in the time of the Civil War expelled gold 
and silver from circulation. When gold and silver were both 
freely coined it was impracticable for a government to 



MONEY 315 

maintain the two forms of money at an absolute parity. 
At one time an ounce of gold might be worth sixteen ounces 
of silver; if then silver and gold were coined at a ratio of 
sixteen to one, — that is, if a dollar in silver contained six- 
teen times as much pure metal as a dollar of gold, — the 
two forms of money circulated at par. Changes in the rela- 
tive production of the two metals, or changes in the demand 
for them, over which no government had complete control, 
caused silver to rise or fall relatively to gold. Since the 
value of coined metal, when coinage was free, could not 
differ perceptibly from the value of uncoined metal, a rise 
in the market value of silver, relatively to gold, raised the 
value of silver dollars above that of gold dollars. In such 
case the gold displaced the silver from circulation. A fall 
in the market value of silver resulted in a displacement of 
gold from the coinage. 

In the monetary history of the United States, silver was 
at one time overvalued, in terms of gold; at another time 
it was undervalued. As a result there was at one time a 
tendency for gold to displace silver from the coinage; at 
another time silver tended to displace gold. The impossi- 
bility of keeping freely coined gold and silver at an absolute 
parity was one of the principal causes for the general 
adoption by the chief commercial nations of the mono- 
metallic system. 

9. The value of money is its purchasing power. 

Under present conditions all men accept money in ex- 
change for their possessions solely with reference to its em- 
ployment in the purchase of other things. We may, there- 
fore, define the value of money as its power to command 
other things in exchange, or briefly, its purchasing power. 
Other commodities are valued by some men for what they 
will bring in exchange, by other men for the satisfaction to 
be derived from them directly or indirectly. The ultimate 
cause of the value which men who hold ordinary commod- 



3i6 INTRODUCTION TO ECONOMICS 

ities for sale ascribe to such commodities is the value as- 
cribed to them by those who will use them in the satisfac- 
tion of wants. There are practically no men who ascribe 
value to money as a means of direct satisfaction. In this 
respect, accordingly, the value of money is a unique phe- 
nomenon, requiring special explanation. 

10. The value of money is measured by its power to 

command commodities in general. 
The value of money, then, is its purchasing power. 
How is this power to be measured? Evidently not by 
reference to any particular commodity. A dollar may buy 
one and one quarter bushels of wheat to-day and only one 
and one fifth bushels to-morrow. We should not say that 
the value of money has declined, but that the price of wheat 
has risen. For there are probably many other commodities 
in respect to which the purchasing power of money has 
increased. To form a true estimate of the value of money 
we must consider its power to command commodities in 
general. In order to measure changes in the value of 
money we may form a Hst of the principal commodities, 
showing how much of each a dollar will command at differ- 
ent dates. By the method of averages we can then ascer- 
tain whether the general purchasing power of money has 
changed. This method has long been employed by econo- 
mists, and it has been shown that through long periods of 
time the value of money fluctuates widely. A dollar bought 
in 1 9 14 twice as much as in 1922. Very likely a dollar 
will buy much more in 1932 than in 1922. 

11. Changes in the supply of money tend to bring 

about changes in the value of money. 
The factors which determine the value of money, and 
hence the general level of prices, are so numerous and com- 
plex that only a provisional account of them can be given 
in this work. It is quite generally agreed that, other things 
equal, the greater the volume of money there is in the 



MONEY 317 

world, the lower will be the value of any unit of it. It is, 
of course, true that there are in operation many influences 
affecting prices besides changes in the volume of money. 
Hence we cannot say that if the volume of money, twenty 
years hence, shall be twice as great as it is to-day, prices 
will be higher than they are to-day. Yet this fact does 
not make it the less important for us to gain a clear view of 
the effect of a change in the volume of money. 

Let us suppose that through the discovery of a new gold 
field the world's supply of that metal is perceptibly in- 
creased: $100,000,000 worth of gold, let us say, is taken 
from the new mines every year. Some of the new gold 
may be used in the arts, but the greater part of it will find 
its way to the mints of the nations, and issue thence as 
coin. 

The only use which money subserves is that of purchas- 
ing other commodities. The fortunate owners of the new 
mines will therefore enter the market as purchasers, either 
of consumable commodities or of capital goods or rights 
to capital goods — stocks, bonds, etc. There is no reason 
why the production of goods, whether consumable goods 
or instruments of production, should at once increase upon 
the discovery of gold. We may think of the supply of 
such goods as substantially unchanged. Now, new pur- 
chasers, with $100,000,000 to spend, appear upon the mar- 
ket. It is quite evident that competition for commodities 
will increase, and hence prices will rise. 

Let us assume, for the moment, that the rise in price of 
the commodities purchased by the first owners of the new 
gold has no effect in stimulating the production of such 
commodities. The enterprisers engaged in the production 
of these commodities, then, will enjoy abnormally large 
money incomes as a result of the high prices at which they 
sell their products. They will have more money to spend 
on other classes of commodities for their own use. As the 



3i8 INTRODUCTION TO ECONOMICS 

production of these, we assume, has not yet been affected, 
they also must rise in price. And so the new gold will 
percolate from one economic stratum to another, every- 
where raising prices. 

Our assumption that the production of the commodities 
demanded by the original owners of the new gold remains 
unchanged is purely arbitrary. The rise in prices would 
probably lead enterprisers to enlarge their mills, or to run 
them overtime, and this would require more laborers and 
more capital. The total supply of labor and capital at the 
command of society has not, however, been affected by the 
increase in the volume of money. The only way, then, in 
which an enterpriser can secure additional labor and capi- 
tal is by enticing these agents away from the employment 
of other enterprisers. And this, it is evident, must raise 
the rates of wages and interest in the district where the ex- 
pansion of enterprise occurs. 

After the rise in wages, each laborer has more money 
to spend; he will therefore seek to increase his purchases 
of the commodities suitable for his use. The supply of 
these, however, has not yet increased ; their price is, there- 
fore, forced to a higher level. Similarly the increased 
money income of the capitalists raises the prices of commod- 
ities taken by the members of that class. Eventually not 
only the price of all finished products, but the price of all 
raw materials and other capital goods, and of all labor, will 
be affected. 

The new gold may be first used to purchase consumable 
goods, or it may be used to purchase stocks or bonds. In 
the latter case, the first effect is an increase in the price of 
these securities. But the sellers of the securities will use 
the money to buy other things. Eventually the effect must 
be felt in the market for commodities and labor. 



I 



MONEY 319 

12. The issue of paper money by a government, if 
conducted with moderation, affects prices in 
the same way that an increase in standard 
money affects them. 
Instead of assuming that the supply of money is in- 
creased through new gold discoveries, we may assume that 
such increase in the money supply is brought about through 
an issue of a moderate amount of paper money by the 
government. Suppose that the United States Government, 
in order to finance projected irrigation works, issues $100,- 
000,000 in paper money. This money will find its way into 
circulation through the purchase, by the Government, of 
additional supplies and the payment of wages to new em- 
ployees. The supply of steel, cement, and other commod- 
ities needed by the Government, however, is not increased 
at once by the issue of new money; hence the price of 
these supplies must rise when the Government enters the 
market as an unanticipated purchaser. Similarly, wages 
are forced up by the new demand for labor created in this 
way. Through attempted expansion of business and through 
increased Hberality of expenditure, the enterprisers and 
laborers first affected by the increase in the money supply 
transmit its effects, in the form of increased prices, to men 
engaged in other industries. In the end general prices and 
general costs are on a higher level than they would other- 
wise have been. 

If, however, a government falls under control of men who 
are willing to carry the issue of paper money to extremes, 
its value is determined on quite different principles. The 
announcement that new issues are contemplated causes a 
rapid fall in the value of money and a corresponding rise 
in general prices even before a single new note has been 
issued. On the other hand the announcement that no 
more paper will be issued for, say, six months, causes an 
instant rise in the value of the money. Rumors indicating 



320 INTRODUCTION TO ECONOMICS 

the fall of the issuing government would cause a great 
decline in the value of its money, quite irrespective of the 
demand for money as a medium of exchange. 

13. The employment of substitutes for money in 

ejecting exchanges operates as an increase in 

the supply of money. 
Not all exchanges are effected through the medium of 
money. Barter exists even to-day, although this form of 
exchange may be ignored, as of very slight importance. 
Many exchanges — indeed, much the greater number, in a 
society like our own — are effected through the medium of 
various substitutes for money. Let us suppose that A, a 
person of unquestioned financial standing, buys of B com- 
modities worth $ioo, and instead of paying cash, gives a 
promissory note, due in six months. B in turn may buy 
$ioo worth of goods from C, paying for them not with 
cash, but with A's note, properly indorsed. C may use 
the same note to effect a purchase. At any given time a 
vast number of such notes may be at work effecting ex- 
changes, although each one may be transferred only two 
or three times before its maturity. The effect of the use 
of such notes as a means of exchange is the same as that 
of an increase in the supply of money. A man who can 
use a note in this way is enabled to enter the market for 
the purchase of goods as he could not have done if sellers 
all insisted upon cash payment. The effective demand for 
commodities, therefore, is increased, just as it would be by 
an increase in money. We need not at this point carry 
further the analysis of the effects of the introduction of 
such substitutes for money, as these effects will receive full 
discussion in the next chapter. 

14. Changes in the volume of business affect the value -^ 

of money. 
The value of money, as we have seen, is affected by 
changes in the volume of money and in the use of substitutes 



MONEY 321 

for money. It is also affected by changes in the volume of 
business to be transacted through the use of money. Where 
most men produce for themselves the principal commodities 
which they need, exchanging only their surplus for lux- 
uries, a very little money will meet the requirements of 
trade. Where, on the other hand, men produce almost ex- 
clusively for sale, a large volume of money or of substitutes 
for money is required. If we imagine that men suddenly 
change from the system of production for immediate con- 
sumption to the system of production for the market, with- 
out any change in the volume of money and of its substi- 
tutes, we can easily see that the price level must be lowered. 
Where one commodity under the earlier system was of- 
fered for sale to the possessors of money, one hundred may 
be offered under the later system. Some sellers of commod- 
ities would then find that at the scale of values originally 
existing they would be unable to find purchasers with money 
to pay. They would accordingly reduce prices, and so 
attract to themselves a part of the money supply. This 
would leave other sellers without buyers, and these in turn 
would lower prices. Thus the price level would fall or, 
what amounts to the same thing, the value of money 
would rise, until all sellers could find buyers at the prevail- 
ing prices. 

The assumption that the system of production could 
change thus rapidly without a change in the volume of the 
media of exchange involves unrealities, as we know that 
exchange and the medium of exchange must evolve to- 
gether. Yet it points to a real fact: that exchange may 
expand more rapidly than the volume of the media of ex- 
change, necessitating a lower price level. 



322 INTRODUCTION TO ECONOMICS 

15. An increase in the supply of money tends to 
raise prices; hut there is no definite relation 
between the degree in which the money supply 
is increased and the degree in which prices rise. 
It must now be evident that changes in the volume of 
money are not alone sufficient to explain changes in the 
value of money, or price changes. The development of 
substitutes for money and changes in the volume and 
character of business transactions must also be taken into 
account. Therefore, although we may say that an increase 
in the volume of money will, other things equal, raise 
general prices, we cannot say in what degree any specific 
addition to the money supply will raise prices. A doub- 
ling of the money supply of the world might conceivably 
double prices. In all probability, however, prices would 
be increased by less or by more than one hundred per cent. 
For the readjustments consequent upon such an extraor- 
dinary expansion in the volume of money would probably 
result in vital changes in the volume and character of 
business, the nature of which it would be impossible to 
predict. The reader is cautioned against the view that 
an increase in the money supply, brought about in any 
way that is known to practical experience, can leave the 
industrial mechanism unchanged while changing the scale 
of prices. 

We may also say that, other things equal, all prices will 
be raised by any important increase in the volume of money. 
But we cannot say that all prices will rise in the same pro- 
portion. Indeed, this is something that a little reflection 
on business conditions shows to be impossible. The supply 
of some commodities is easily increased, while the supply of 
other commodities can be increased only after the lapse of 
considerable time. If the new money is spent largely on 
commodities of the first class, the attendant rise in prices is 
quickly counteracted, in some degree, by increase of pro- 



MONEY 323 

duction. If it is spent on commodities of the second class, 
there can for a time be no such counteracting influence. 
We can imagine that the first impulse of the beneficiaries 
of ''easy money" is to acquire high-priced automobiles. 
This would raise the prices somewhat, but production 
would increase and prevent the prices from going to im- 
moderate heights. We can also imagine that this first 
impulse is to acquire antiques and Old Masters. There is no 
assignable limit to the possible rise in prices of such goods. 

16. Changes in the volume of money give rise to prac- 
tical economic questions of the greatest im- 
portance. 

The fact that not all prices rise in the same degree, and 
the fact that some classes of business relations cannot be 
immediately adjusted to price changes, renders the question 
of increase or decrease in the volume of money of vital 
practical importance. Some social classes are affected fa- 
vorably and other classes are affected adversely by such 
changes. 

When general prices are rising, the wages of labor also 
tend to rise. But it may take some time after prices have 
begun to rise before enterprisers decide to extend their 
business operations. The demand for labor, accordingly, 
does not for a time increase and wages remain unchanged. 
The laborer receives no higher wages per week or month; 
the commodities he buys with his wages have risen in price. 
It follows that the command of the laborer over the nec- 
essaries and comforts of hfe is for the time diminished. 
Eventually, to be sure, enterprisers will endeavor to en- 
large their businesses, and wages will rise. But if the prices 
of commodities continue to rise, it may well be that for a 
long period of time the rise in money wages will not be an 
adequate offset for the increased expense of living. It is a 
well-known fact that during the Civil War the prices of 
commodities rose far more than the price of labor. Ameri- 



324 INTRODUCTION TO ECONOMICS 

can wages kept closer to the general price level during the 
Great War, chiefly because the special position of the United 
States made possible an enormous increase in production 
from which both wages and return to capital could be in- 
creased. Nevertheless, although labor was more fully em- 
ployed in 1 918 than in 19 13, the purchasing power of the 
average yearly wages declined by about five per cent. 

For many services compensation is fixed by law or by 
custom. The salaries of public officials remain fixed through 
long periods of time, notwithstanding changes in the price 
level. The postal employee receiving $2000 a year is seri- 
ously injured if prices of commodities rise, since years may 
elapse before the Government grants him an increase of 
salary. Physicians' fees, in most cases, are regulated by 
custom and can seldom be increased on account of an ad- 
vance in general prices. 

The business relations most seriously disturbed by price 
changes, however, are those of creditor and debtor. Let 
us suppose that a farmer has borrowed $10,000, agreeing 
to pay off the loan in ten years, together with annual inter- 
est at six per cent. After the contract has been made, 
general prices, we will assume, rise twenty per cent. The 
farmer does not have to pay more than $600 interest each 
year, although the purchasing power of that sum has de- 
clined twenty per cent. At the end of the ten years, he 
will not need to pay more than $10,000, although this sum, 
for the same reason, represents a lower value. The creditor 
has been injured through the change in the price level just 
as much as he would have been if the debt had been arbi- 
trarily scaled down to $8333, prices remaining unchanged. 
The farmer, on the other hand, has gained materially. He 
receives higher prices for what he has to sell, and so is 
enabled to pay the annual interest and the principal when 
due with much less sacrifice than would otherwise have 
been necessary. 



MONEY 325 

It has already been indicated that the relations of debtor 
and creditor are thrown into confusion by such extreme 
fluctuations in the value of money as followed the Great 
War, especially in Central Europe. In large part the 
creditor class was simply eliminated. Persons who Hved 
before the war on interest from government bonds and 
on the returns from mortgage loans and the Hke were 
thrust into the ranks of the propertyless. 

Enterprisers as a class are benefited through a rise in 
general prices. What they have to sell commands a higher 
price; their costs of production increase, but not propor- 
tionately. Mention has already been made of the fact that 
wages may not rise so rapidly as prices. Furthermore, 
most enterprisers have some charges to meet that remain 
unchanged from year to year. If they occupy buildings 
and land not owned by themselves, these are probably 
held under long time leases. Until it is necessary to re- 
new such leases, the rental cannot be adjusted to the 
change in the price level. Most enterprisers are heavily in 
debt, and the rise in the level of prices has the effect of 
reducing the burden of such debts, as in the case of the 
farmer of Our illustration. A period of rising prices, to the 
active business man, is, therefore, a period of prosperity, 
whether it is a period of prosperity to the people as a 
whole or not. 

We have only to reverse our argument to show that 
in a period of falling prices, or rising value of money, the 
wage earners as a class gain, because wages do not fall so 
rapidly as prices, unless, as is not unlikely to happen, the 
attendant industrial depression produces general unem- 
ployment; those receiving salaries fixed by law or custom 
gain yet more, because a readjustment of such incomes to 
the new scale of prices is long delayed; creditors gain 
through increase in the purchasing power of the interest 
and principal due them. The enterprisers as a class find 



326 INTRODUCTION TO ECONOMICS 

profits succeeded by losses, and complain bitterly of busi- 
ness depression. 

17. A monetary standard of fluctuating value results 
in serious hardships; it is therefore natural 
that eforts should he made to render the 
standard more stable through governmental 
action. 
The value of money can neither rise nor fall without in- 
flicting unmerited hardship upon some members of society. 
Any change in the value of money, therefore, is an evil. 
The evils of a rise in the value of money are, however, 
more easily perceived than the evils resulting from a fall 
in the value of money. When money rises in value — 
or, what amounts to the same thing, prices fall — enter- 
prisers incur losses, and restrict their operations, reducing 
their working force as far as possible. Many debtors find 
themselves unable to sustain their burdens, and become 
bankrupt. The hardships of unemployment and bank- 
ruptcy quickly attract pubhc attention. The hardships 
arising from a fall in the value of money, or rising prices, 
are more widely diffused and less patent to the eye of 
the observer. Wage earners and the recipients of fixed 
incomes, whether from labor or from loaned capital, en- 
counter greater and greater difficulty in making ends 
meet, but this fact receives httle attention at a time when 
enterprisers great and small are enjoying prosperity. 
Accordingly, it is quite natural that when prices are fall- 
ing men should endeavor to mend matters through the 
action of government, while the evil effects of a general 
rise in prices are usually left to mend themselves. Or 
if the rise in prices is so rapid that the majority suffer 
keenly under the increased cost of living, the evil is 
usually assigned to other causes than the true one. The 
enterprisers and all the series of dealers between them 
and the consumer are accused of joining in combinations 



MONEY 327 

to hoist prices and of profiteering. In countries of fluc- 
tuating paper standards the first evidence of declining 
money value which the ordinary consumer encounters 
consists in the marking up of prices by the retail dealer. 
That looks hke an arbitrary practice, designed to extort 
profits out of the consumers, and consequently often pro- 
duces rioting, or at least an enraged public sentiment 
which forces the government to take action looking to 
price control. Such action seldom achieves its purpose. 
It serves only to divert attention from the true cause of 
the difficulty. 

18. In order to check the fall of prices which oc- 

curred in the period from 1874 to 1897, 
it was urged by many that silver should he 
restored to free coinage, so as to increase 
the money supply of the world. 
In the period from 1874 to 1897 the prices of com- 
modities steadily declined. In 1897 a dollar would pur- 
chase approximately the same amount of commodities 
that $1.50 would have purchased in 1874. Many classes 
of producers were seriously injured by this decline in 
prices; business depression appeared at times to threaten 
widespread ruin. The debtor classes in all modern coun- 
tries were seriously burdened, and in some parts of the 
United States, especially in the newer agricultural states 
of the West, a popular demand arose for an increase in 
the supply of money through the restoration of silver to 
free coinage at the ratio of 16 to i — the ratio prevailing 
in the United States prior to 1873. 

19. The adoption of free silver in 1896 would 

probably have expelled gold from circulation 
in the United States. It would have re- 
duced the value of gold and would have 
raised the value of silver. 
In 1896 the market value of silver had fallen so low 
that an ounce of silver was worth less than one thirtieth 



328 INTRODUCTION TO ECONOMICS 

of the value of an ounce of gold. Consequently, if silver 
had been admitted to free coinage, it would have been 
very profitable to buy up uncoined silver, both in America 
and in other countries, present it at the mints, and ex- 
change the coined silver for gold, so long as any gold coins 
remained in circulation. It would obviously have been 
only a very short time before gold would have disap- 
peared entirely from circulation. 

The great demand upon the silver supply that would 
thus have been occasioned would no doubt have increased 
the value of that metal. The gold displaced from the 
American coinage would have been thrown upon the 
markets of other countries, and would have reduced the 
value of gold there. Nevertheless, an ounce of gold would 
probably have continued to command more than sixteen 
ounces of silver — perhaps twenty ounces. A silver dollar 
would then have been worth less than a dollar in gold, even 
though gold had fallen. Measured in commodities, the de- 
preciation of the dollar would have been still greater. That 
is, general prices in the United States would have been 
forced to a higher level. 

20. An international agreement for the universal 
adoption of bimetallism might have pre- 
vented freely coined silver from expelling 
gold from the currency. 

Many persons who shrank from a policy which would 
probably have substituted a silver standard for the gold 
standard in the United States, nevertheless favored the 
adoption of free coinage of silver if the other commercial 
nations could be induced to follow the same plan. 

If all the countries of the world had agreed to coin sil- 
ver and gold freely at the same ratio, it is quite possible 
that coins of both metals would have continued to circu- 
late side by side. The chief reason why gold would leave 
the circulation of a single country, if placed at an un- 



MONEY 329 

favorable ratio with freely coined silver, is that in other 
countries it is given a higher coinage value. More gold 
would be used in the arts, perhaps, but much of it would 
remain in the coinage if all countries gave it the same 
coinage value, relatively to silver. 

21. Rise in prices in the period beginning with 

1897 checked agitation for the free coinage 
of silver. 
The adoption by the chief nations of free coinage of 
silver would no doubt have resulted in a higher level of 
prices. Other forces affecting prices had, however, begun 
to operate while the free-silver movement was still gain- 
ing strength. The production of gold was steadily in- 
creasing; in the decade 1890 to 1900 the amount of gold 
produced exceeded that of any earlier decade in the 
history of the world. The annual production steadily 
increased down to the time of the Great War. In 1913 
the output of gold was over twice as great as it was in 
1897. It fell off during the war and the years immedi- 
ately after its close, but not seriously. This increase in 
the supply of gold must have had a tendency to reduce 
its value, or, what amounts to the same thing, to raise 
the prices of commodities. When it became evident that 
the rise in prices was likely to continue, agitation for the 
adoption of the policy of free coinage of silver practically 
ceased. 

22. A government may raise or lower the value of 

money by increasing or reducing the amount 

of paper money in circulation. 
The evils of falling prices are so readily perceived by 
almost every one, that in times of falling prices plans are 
usually put forward for releasing the price level from the 
uncertainties attendant upon the production of gold and 
silver by supplementing metallic money with paper money 
issued by government. Advocates of such plans usually 



330 INTRODUCTION TO ECONOMICS 

propose that whenever general prices are found to be 
falling, the government shall issue additional paper 
money. When prices are rising, paper money received 
at the public treasury, it is proposed, shall be destroyed, 
until a reduction in the money supply checks the rise in 
prices. 

In practice, paper money, when issued, usually takes 
the form of notes, issued in behalf of the government and 
alleged to be payable at the treasury on demand. But a 
government of a sovereign state cannot be compelled to 
meet its promises unless it chooses to do so. Hence the 
person who receives such a note must take it with the in- 
tention of parting with it in the purchase of goods or in 
the payment of debts, not of presenting it at the treasury 
for specie. These notes therefore represent a net addi- 
tion to the money supply. 

In order to give such notes currency, the government 
endows them with the legal tender quality. If the volume 
of paper money is narrowly limited, it may circulate at 
par. It is always good in transactions with the govern- 
ment, such as payment of taxes, and so long as the aver- 
age citizen does not have to carry more in his purse than 
he could presumably use in such ways, there is no reason 
why he should discriminate against it. In a country 
like the United States, where over five bilHons of dollars 
must be paid in taxes, federal, state and local, some 
hundreds of miUions of paper would circulate even with- 
out formal arrangements for redemption. 

If, however, an enormous amount of paper money is 
issued by the government, so that we are all likely to re- 
ceive more of it in exchange than we can certainly use at 
par, we begin to look upon it with suspicion. We ex- 
change it, if we can, for ''hard money" — gold or silver; 
if possible, we stipulate that we shall be paid in hard 
money for our commodities or services, offering our goods, 



MONEY 331 

if necessary, at lower prices than we would accept if paid 
in paper. Relatively to gold, paper depreciates. If there 
is very much of it issued, no one pays gold if he can avoid 
it, but uses paper instead. Thus specie disappears from 
circulation, and paper becomes the only money in use. 
Under the circumstances it is the worst possible kind of 
money: it fluctuates wildly in value, falling with rumors 
of additional issues, rising when it is rumored that the 
government intends to redeem it. At every change in its 
value some men gain unmerited profits and others suffer 
unmerited losses. 

If, as has been said, a government exercises great mod- 
eration in the issue of paper money, depreciation will 
not necessarily occur. The increase in money will tend 
to raise prices, but not in very great degree, and if prices 
are tending downward this effect may be beneficial. 
Why, then, do practically all students of monetary 
science agree that paper money is always a dangerous 
expedient? Because governments almost never exercise 
moderation in the issue of paper money. They resort to 
paper money in time of need, usually while carrying on 
war. Thus they obtain funds without burdening the 
people with taxation. As the expenses of the war in- 
crease, more and more paper money is issued, until hard 
money is driven out of circulation, and the redundant 
paper currency falls lower and lower in value, as evi- 
denced by constantly rising prices. 

During the. Great War every belligerent nation except 
Japan and the United States resorted to the issue of 
paper money either directly or through unsecured bank 
note issues endowed with legal tender quality. And in 
not a single case did the government arrest the process 
of issue before gold had been excluded from the circula- 
tion and the paper had depreciated seriously. The 
British currency suffered least, falling off only about 



332 INTRODUCTION TO ECONOMICS 

twenty per cent from its gold value. The currency of 
Russia, at the other extreme, was inflated by issues 
running up into the trillions of rubles, with the result 
that a hundred thousand ruble note, nominally the 
equivalent of fifty thousand dollars, would barely com- 
mand a square meal. The experience of Europe in the 
war and the post-war period proves quite conclusively 
that paper money is Hke a habit-forming drug, requiring 
constantly increasing doses. 

While it would be theoretically possible to regulate 
prices by a scientific plan of increasing or reducing the 
volume of paper money in circulation, actual experience 
demonstrates conclusively that no such plan will work 
in practice. It would be a simple matter to increase the 
volume of paper money when prices are falling. The 
government would print the money and spend it, no 
doubt to the satisfaction of a public which observed 
public works being undertaken without any increase in 
the burden of taxation. But the plan would break down 
when an attempt was made to check rising prices by 
withdrawing paper from circulation. Before the govern- 
ment could withdraw the money it would have to take 
it away from the citizens through taxation. And in- 
creased taxes having no other object than that of keep- 
ing prices down would be so unpopular that no political 
party desiring to remain in power would be wilUng to 
propose them. 

Might there not be some way of taking the regulation 
of the supply and value of money out of politics and of 
subjecting it to expert control? 

In recent years an active campaign for the stabiliza- 
tion of money has been conducted by a number of Amer- 
ican economists under the leadership of Professor Irving 
Fisher. The scheme of regulation proposed by Professor 
Fisher turns upon varying the amount of gold entering 



MONEY 333 

into the ''dollar." The business world is already habit- 
uated to the use of certificates for gold deposited, instead 
of the gold itself. There is no compelling reason why the 
gold held against certificates should always remain the 
same. When prices are rising relatively to gold, let the 
treasury require an increased amount of gold before 
delivering, say, a twenty dollar certificate. When prices 
are falling relatively to gold, let the amount of gold re- 
quired for the delivery of a twenty dollar certificate be 
reduced. To-day a twenty dollar certificate represents 
416 grains of gold, nine- tenths fine. Under the stabiKza- 
tion scheme it might represent at one time 400 grains, 
at another time 425 grains. A body of expert price sta- 
tisticians, aloof from the political fortunes of the govern- 
ment, would determine what the gold content of the 
dollar should be. Perhaps they could not establish per- 
fectly stable prices. But there is every reason to believe 
that a far more stable medium could be established in 
this way than by the ordinary play of supply and de- 
mand under gold monometallism. The chief obstacle to 
the application of the plan is not any valid criticism that 
has been brought against it, but the inherent conserva- 
tism of the financial classes, who fear that any tampering 
with the gold standard may bring consequences wholly 
unforeseeable. 

23. A currency based upon gold or silver freely 
coined displays a tendency toward reason- 
able stability of value under modern con- 
ditions. 
So long as the production of the precious metals was 
dependent upon the activity of men of small capital, 
working on their own account, only the richest fields 
could be worked, and these only for a limited period of 
time. The supply of precious metals depended, therefore, 
upon the chance discovery of new fields, and was conse- 



334 INTRODUCTION TO ECONOMICS 

quently very irregular. At present the principal supply 
of the precious metals comes from the reduction, by large 
scale enterprise, of low grade ores, which are found in 
large masses in many parts of the world. If the supply 
of gold increases so rapidly that the value of gold money 
falls, or, what amounts to the same thing, general prices 
rise, the production of gold is discouraged through the 
rise in price of labor and the materials and appliances 
used in gold production. If the supply of gold does not 
keep pace with the demand for it, and general prices fall, 
the production of gold is encouraged by the decline in 
wages and in the prices of goods used in the production 
of gold. We see, then, that there are forces at work 
which restrict fluctuations in the value of money. We 
must not, however, exaggerate the potency of these forces. 
Within limits which are not so narrow as would be so- 
cially desirable, the value of freely coined money fluctu- 
ates from year to year and from decade to decade. 

24. Summary. 

Whatever men regularly accept in payment' for their 
services or in exchange for their goods, with the sole pur- 
pose of exchanging it for other services or goods, is 
money. The primary function of money is that of a me- 
dium of exchange; money serves also as a means of stor- 
ing value, as a standard of value, and as a standard of de- 
ferred payments. 

In order that money may be uniform in value, its issue 
must be regulated by government. As a rule, a standard 
form of money is established, and the government merely 
certifies the weight and fineness of metal contained in this 
form of money. Other forms of money are issued in 
limited quantities, and it is the aim of a well-regulated 
government to maintain these forms at a parity with the 
standard form. If there is more than one standard form, 
maintenance of parity between them is difficult, if not im- 



MONEY 335 

possible. When a government fails to maintain its 
various forms of money at a parity, the less valuable 
forms tend to displace the more valuable forms from the 
circulation. 

The value of money is measured by its purchasing 
power. The purchasing power of money is continually 
fluctuating, owing to changes in the supply of and the 
demand for money. Changes in the supply of money 
may be due to changes in the output of the metal from 
which standard money is made, or to changes in the 
volume of non-standard forms issued by government. 
Changes in the demand for money may be due to changes 
in the general character of business, or to increase or de- 
crease in the volume of substitutes for money. 
I A rise in the value of money is tantamount to a fall 
in prices; a fall in the value of money, to a rise in prices. 
General changes in the price level inflict serious injury 
upon some classes and give unmerited gains to other 
classes. Hence a popular demand for governmental 
regulation of the price level through expansion or contrac- 
tion of the money supply. The free silver movement of 
the end of the last century is explainable upon this prin- 
ciple. The adoption of free silver by the United States 
would probably have raised the world level of gold prices; 
it would have placed prices in the United States upon a 
silver basis. 

Under ideal conditions, general changes in the price 
level might be prevented through the issue or retirement 
of paper money. Under existing conditions, since the 
pressure for higher prices is always stronger than the 
pressure for lower ones, a consistent pohcy of issue of 
paper money is impracticable. It is conceivable that a 
plan of regulation through varying the gold content of 
the "dollar" might bring a fair degree of stability. In 
default of the application of such a plan, the only prac- 



336 INTRODUCTION TO ECONOMICS 

ticable corrective of rising prices is the automatic reduc- 
tion in the output of gold resulting from the increased 
cost of extracting gold from the ore, just as the only 
practicable corrective of falling prices is the automatic 
increase in the gold supply resulting from lower cost of 
gold extraction. 



CHAPTER XVII 

FINANCIAL INSTITUTIONS: THE BANK 

1. An important function of the modern economic 
organization is the placing of the control of 
capital in the hands of those who can use it 
to the greatest advantage. 
In a complex industrial society it is natural that there 
should be some men possessing capital who are unable or 
unwilling to employ it in business undertakings under 
their own management. Some men, while able to use 
part of their capital in the conduct of business under their 
own control, are unable to use all of it advantageously. 
And some men, while able to use all their capital part of 
the time, fail to find use for it during some weeks or 
months of the year. On the other hand, there are those 
who have not enough capital of their own for the proper 
exploitation of the opportunities for its employment which 
they command, and still others, while having capital 
enough during the greater part of the year, require an 
additional amount during certain seasons. 

Accordingly, one of the functions of the modern indus- 
trial organization is the transfer of the control of capital 
from those who have a superfluity of it to those who can 
use it profitably. This function, which in view of the 
enormous amount of capital to be thus transferred is one 
of vast importance, may be designated by the term 
'^ finance." Institutions designed primarily to effect the 
transfer, or ''placing," of capital are known as financial 
institutions. It is to be noted that we are here using the 

337 



338 INTRODUCTION TO ECONOMICS 

word ''finance" in a sense in some respects more re- 
stricted, in some respects broader, than is usually con- 
veyed by the term. But we are justified in this by the 
analogies of such words as ''capital," "rent," "labor," 
etc., which have one meaning in economics and a slightly 
different meaning in popular language. 

2. The transfer of the control of capital may take 
the form of a loan, of a partnership agree- 
ment or of the purchase of shares of stock. 

Let us suppose that a mine operator holds a lease of ad- 
vantageously situated coal lands. To develop these lands 
he needs, we will say, a capital of $100,000. A retired 
merchant in the vicinity has $100,000 from which he de- 
sires to get an income without the labor of managing a 
business on his own account. The mine operator may 
borrow the $100,000, agreeing to pay a stipulated rate of 
interest. On the other hand, he may be willing to form 
a partnership with the owner of the capital, agreeing to 
share the profits in fixed proportions. In either case the 
capital is virtually placed under the control of the mine 
operator. From a legal point of view the distinction 
between the two methods of transfer of capital is clear. 
If the transfer is effected through a loan, the mine opera- 
tor becomes the legal owner of the goods in which the 
capital is invested, subject to the claims of the lender for 
interest and principal. The lender has no voice in the 
management of the business. If the transfer of capital 
is effected through a partership agreement, the capitalist 
becomes part owner of all the capital goods employed in 
the business, and is entitled to a voice in the management 
of it. From an economic point of view, the chief distinc- 
tion is that in the case of a loan transfer of capital, the 
capitalist receives a fixed income, not affected by the 
vicissitudes of the business, while in the case of the 
partnership transfer, the capitalist receives a share of the 



FINANCIAL INSTITUTIONS: THE BANK 339 

proceeds of the business, fluctuating with the alternation 
of prosperity and depression. 

Instead of making himself partner in the mining enter- 
prise, and assuming all the liabilities of partnership, the 
retired merchant may induce the coal operator to form a 
corporation with a share capital of, say, $200,000, of 
which the operator retains one half and the merchant 
takes the other half in exchange for his $100,000. As 
stockholder, he is part owner, just as he would be as 
partner; the income that he will receive, under the form 
of dividends, fluctuates with the prosperity of the busi- 
ness. If the business fails, the merchant loses his in- 
vestment in it, but no matter how severe the failure, he 
can not be made to make good its liabilities out of other 
resources he may have, as he could be made to do under 
a partnership agreement. 

3. A productive loan is the transfer of capital, 
reduced to terms of money value, usually 
under a definite agreement as to charges for 
its use and as to time of repayment. 
In its simplest form a loan is a transfer of a sum of 
money from one person to another, with the stipulation 
that a certain return shall be paid for its use and that at 
some future time, usually specified, an equivalent sum of 
money shall be repaid. The borrower naturally trans- 
forms the money thus obtained into goods at the earHest 
possible moment. If the goods purchased are designed for 
sale or for use in further production, the loan is virtually 
the transfer of capital. Such a loan is called a produc- 
tive loan. If the money is spent for commodities for 
consumption, the loan is called a consumer's loan. The 
productive loan is by far the more common, and we shall 
concern ourselves chiefly with it. 



340 INTRODUCTION TO ECONOMICS 

4. A loan may be disguised under the form of a 

sale. 
Very frequently loans are disguised under the form of 
sales "on credit." The seller, instead of demanding spot 
cash for his wares, may agree to wait for a certain period 
of time — say, three months — before demanding pay- 
ment. In this case the seller really lends the buyer a sum 
equal to the price of the goods. A company engaged in 
the manufacture of agricultural implements sells a self- 
binder to a farmer. The latter has not the ready cash to 
pay for it, but expects to have the necessary sum four 
months later, when he sells his crops. He may borrow 
the money from a neighbor, giving his note, payable in 
four months, with interest. Or, instead of borrowing the 
money and paying cash for the machine, the farmer may 
buy it "on time," agreeing to pay for it at the end of 
four months. In this case we sometimes say that the 
farmer has purchased the machine with his credit. If we 
analyze the transaction into its elements, we shall see 
that this expression is inadequate. The company has not 
merely sold the machine; it has also, in effect, loaned the 
farmer the money with which to pay for it. Moreover, 
it has made provision for interest on the loan, in the 
form of a higher price on a credit sale than on a cash 
sale. Every sale "on time" or "on credit" is a double 
transaction, involving a sale, in the proper sense of the 
word, and a loan of the capital represented by the goods 
sold. 

5. Lenders intrust the control of their capital only 

to those who have " credit '\' that is, reputa- 
tion for honesty and ability to meet their 
financial obligations. 
It is, of course, obvious that loans, whether productive 
or consumer's, will be made only to persons who have 
"credit"; that is, to persons who are regarded as sufh- 



FINANCIAL INSTITUTIONS: THE BANK 341 

ciently honorable and efficient to be willing and able to 
repay the sums loaned when they fall due. A man's 
credit may rest upon his reputation for personal integrity 
and business capacity; more commonly it rests, in part 
at least, upon the fact that he has property which, under 
the law, can be seized by his creditors in case of default 
in payment of his debts. 

There are some writers on economics who regard credit 
as a mysterious productive instrument, a form of capital, 
or at any rate a substitute for capital. The illustration 
given in section 4 shows that this view has no justifica- 
tion. What the farmer cuts his wheat with is a capital 
good, embodying capital furnished either by his neighbor 
or by the agricultural implement company. This capital 
existed before the farmer gained possession of^it, and 
would doubtless have been employed productively by 
other persons if the farmer had not decided to buy a 
machine. The fact that he buys the machine with bor- 
rowed capital shows that he believes that he can make this 
capital yield more than the interest which he must pay 
for its use. His '^credit" enables him to procure capital 
to use in an employment which he believes to be superior 
to the average in productivity. If he is right in his opin- 
ion, he is able to keep for himself a part of the product of 
this capital, as a profit. But the profit is not produced 
by his credit, any more than the wheat is cut by it. 
6. A document in which the claim of the lender 
upon the borrower is reduced to written form 
is known as a credit instrument. If the 
claim thus reduced to writing can he sold 
and purchased, it is known as a negotiable 
credit instrument. 
The contract between the lender and the borrower is 
sometimes merely oral, and rests for its fulfillment upon 
the honor of the borrower. In a larger nimiber of cases. 



342 INTRODUCTION TO ECONOMICS 

the lender enters the sums due him upon his books, and 
claims thus entered are usually collectible through the 
courts. This is the common form of loans effected under 
the guise of credit sales. The creditor may draw up a 
form instructing the debtor to pay the sum due at a speci- 
fied time. Such an instrument is known as a "draft" 
or ''bill of exchange." The borrower may, at the time of 
raising the loan, sign a form which specifies the terms of 
the contract. Such an instrument is known as a "promis- 
sory note." The borrower may specify, along with the 
general terms of the contract, certain property belonging 
to him upon which the creditor will have a special claim 
in case of default in payment. A note thus accompanied 
by the pledge of property is commonly known as a 
"mortgage." 

The claim of a creditor upon his debtor is regarded in 
law as a form of property, and may ordinarily be pur- 
chased and sold like any other form of property. Claims 
represented by promissory notes, due bills, and bills of 
exchange are very frequently purchased and sold, or 
"negotiated." They are therefore called "negotiable 
credit instruments," or simply, "negotiable paper." 
Transfer of such instruments is commonly effected by 
indorsement; that is, the original claimant signs an order 
upon the back of the instrument, instructing the debtor 
to pay the sum due to a third party named in the order. 
7. Under modern conditions there is a demand for 
and a supply of loanable capital for short 
periods of indefinite duration, for short terms 
and for long terms. Corresponding with 
these conditions are call or demand loans, 
short term loans and long term loans. 
Capital loans display wide variation in the length of 
time for which the lender surrenders control of his capital. 
Sometimes the lender retains the right of calling for his 



FINANCIAL INSTITUTIONS: THE BANK 343 

capital at any time he desires. Such a loan is known as a 
"call" or '^ demand" loan. Sometimes the date when the 
debt falls due is fixed at thirty, sixty, or ninety days. 
Such a loan is known as a short term loan. Sometimes 
the loan runs for five, ten, or fifty years. In this case the 
loan may be called a long term loan. This variation in 
the Hfe period of loans is a reflection of the economic 
stuation of the various classes of lenders and borrowers. 

At any given time there are men who have more capital 
than they need immediately; they cannot tell, however, 
how soon they may need all they have. On the other 
hand, there are men who can use capital profitably for an 
indefinite period of time, who can yet return it to its 
owner whenever it is demanded. Thus a man who deals 
in stocks and bonds may find exceedingly profitable em- 
ployment for capital in the purchase of such securities 
when prices are rising. If he is operating with borrowed 
capital, he can sell the securities at any time when pay- 
ment is demanded, and so restore the capital to its 
owner. 

Again, there are men who can safely part with the con- 
trol of their capital for a definite period of time — say, 
from one to six months. Corresponding with this class of 
lenders is a class of borrowers who cannot agree to pay off 
a loan on demand, but who are able to make arrange- 
ments for payment at a definite date some weeks or 
months after borrowing the capital. The merchant will 
serve as a type of this class. He can safely purchase a 
stock of goods with the proceeds of a three months' loan, 
feeling quite sure that within the three months he will 
be able to sell the goods and so gain possession of the 
means of repayment. 

Finally, there is a class of lenders who have no desire 
for the early repayment of their capital. With satis- 
factory arrangements made as to the rate of interest to be 



344 INTRODUCTION TO ECONOMICS 

paid, they may be willing to transfer control of their capi- 
tal for a period of ten, twenty, or fifty years. There is a 
corresponding class of borrowers, who desire capital for 
investment in land, buildings, and permanent equipment, 
and who would be greatly embarrassed by the necessity 
of early payment. 

There are, then, three distinguishable sources of supply 
of loanable capital, and three corresponding sources of de- 
mand for it. In practical life, of course, with highly de- 
veloped financial institutions, there is a certain degree of 
interchangeability in the different funds of capital. Let 
us suppose that lenders of the first class place their capi- 
tal in a bank, reserving the right of withdrawing it at any 
time. Experience shows that while some lenders with- 
draw their capital each day, new lenders will each day 
offer capital at the bank. Thus the bank has a permanent 
fund of capital which it may lend to business men for 
stated periods of time. Men who wish to lend their 
capital for long periods of time may place it wjth a bank, 
which may use it in short term loans, experience showing 
that when one business man repays a loan of this kind 
another will be ready to borrow the capital. 
8. The principal functions of the hank are the 
collection of funds of loanable capital that are 
available for short periods only, and the 
employment of such funds in. call and short 
term loans. 
The bank proper is chiefly engaged in providing bus- 
iness men with demand and short term loans. The 
capital employed in this way is in part the bank's own, 
and is permanently devoted to the purpose. By far the 
greater part of the capital, however, is supplied by other 
persons, who loan their surplus funds to the bank, re- 
ceiving for its use either interest or some other form of 
compensation. Provision for long term loans is usually 



FINANCIAL INSTITUTIONS: THE BANK 345 

made by various other financial institutions, such as 
the savings bank, the insurance company, the invest- 
ment company, the farm loan bank, and the exchanges. 
Our present concern is the economic nature of the trans- 
actions in which the bank proper is engaged. 

Let us suppose that a bank is established in a town 
which up to the present has had no similar institution. 
As the bank has doubtless better means for keeping 
money safe than are to be found elsewhere in the town, 
we may suppose that many persons will be glad to 
deposit with it any money which they do not immedi- 
ately need, reserving the privilege of withdrawing it 
whenever they need it. On pay days salaried employees 
will deposit most of their month's earnings, expecting 
to withdraw the money day by day to meet their 
current expenses. Similarly, capitalists will deposit 
their annual or semi-annual interest receipts, to be 
withdrawn in like manner for current expenditures. 
Merchants will deposit surplus cash which they will not 
need to reinvest in stock for some days or weeks. Lend- 
ers whose loans have been repaid will deposit the money 
until they find another satisfactory opportunity for 
lending. Thus a great part of the community will use 
the bank in greater or less degree for the storing of 
surplus funds. The sums so deposited are credited to 
the depositors on the books of the bank. 

The use of checks, or written orders for the transfer 
of funds, greatly increases the usefulness of the bank as 
a repository of funds of this kind. The depositor, instead 
of going in person to the bank to withdraw money for 
a purchase, may give a check for the sum involved in 
the transaction. The recipient of the check may present 
it at the bank for pajnnent, carrying away the sum in 
money. If he is in the habit of depositing his own sur- 
plus funds in the bank, he is more likely to deposit the 



346 INTRODUCTION TO ECONOMICS 

check, instead of cashing it. The sum called for in the 
check is then transferred, on the books of the bank, from 
the account of the one person to the account of the 
other. Thus payment is effected without the handhng 
of money by any one. When the check system is well 
developed funds deposited with the bank may change 
owners scores of times without ever leaving the vaults. 

The cash intrusted to the bank may amount to a 
very considerable sum. At one time such deposits may 
aggregate $50,000, at another time $75,000. Experience 
may show that the volume of deposits never falls below 
$40,000. This sum of $40,000 may be regarded as a 
perpetual fund intrusted to the bank by the body of 
depositors, although actual ownership of each part of 
it is continually changing. 

The bank is, of course, under no obligation to keep 
in its vaults the money that has thus been intrusted 
to it. All that the bank is required to do is to hold itself 
in readiness to pay the money on demand. So long as 
it does this, it may use the deposits in any way that it 
may find profitable — observing, of course, such restric- 
tions in the use of its funds as the law prescribes. And 
this fact indicates the economic nature of such deposits. 
They are loans, payable on demand, the depositor being 
the creditor, the bank the debtor. 

Up to the present point we have been concerned with 
the bank as a borrower of capital. We have now to 
consider its position as a lender of capital. Let us sup- 
pose that one of the inhabitants of the town is a manu- 
facturer of hardware, who sells his products ''on time" 
to jobbers. This manufacturer has sold, let us say, 
$10,000 worth of products, receiving in lieu of payment 
notes for $10,000 at three months' time. This means, 
as we have already seen, that the manufacturer has made 
a disguised loan of capital to the jobbers. The manu- 



FINANCIAL INSTITUTIONS: THE BANK 347 

facturer, however, needs his capital in order to continue 
his business of manufacture. 

He may, if his credit is good, borrow $10,000 from 
the bank, agreeing to repay the loan in three months. 
When his debt falls due, the notes of the jobbers will 
also fall due; accordingly, he will find himself in an 
exceltot position to cancel his debt. Other business 
men will borrow from the bank under similar conditions 
as large a portion of the capital deposited with the bank 
as can safely be loaned. When one set of borrowers 
repays the sums borrowed from the bank, another set 
can easily be found. Thus the bank has a permanent 
volume of loans, as well as a permanent volume of 
deposits, although the borrowers, like the depositors, 
are continually dropping out and being replaced by others. 

9. A bank loan may be regarded as the purchase of 
a credit instrument, such as a promissory 
note or bill of exchange. 

In the foregoing section it was assumed that men who 
wish to secure capital from a bank borrow it directly; 
and this, indeed, is often the case. When a business 
man borrows for the purpose of recovering the control 
of capital which he has loaned, under the form of a sale 
to other persons, he is more hkely to take the notes 
received from the latter to the bank for sale. In buying 
the notes, the bank substitutes itself, as creditor, for 
the business man who first held the notes. If the notes 
bear no interest, the bank, in purchasing them, will 
deduct from their face value interest for the time that 
will elapse before the notes "mature," or fall due. 
This process of deducting interest in advance is known 
as "discounting." In the language of the banking busi- 
ness, the purchase of a note is commonly spoken of as 
the discounting of a note, and notes purchased are called 
"discounts." Discounts are evidently nothing but loans. 



348 INTRODUCTION TO ECONOMICS 

When a person desires to borrow capital from a bank, 
he offers his own note, which the bank usually discounts 
in the manner described above. We may think of the 
borrower as offering his own note to the bank for sale. 
Thus the whole volume of bank loans may be regarded 
as investments in credit instruments. 

10. A bank must invest funds intrusted to it in 
such a way that it can quickly regain posses- 
sion of such funds if necessary. 

While the volume of funds intrusted to a bank may, 
under ordinary circumstances, remain fairly constant, 
owing to the fact that new deposits offset withdrawals, 
it would be unwise for the managers of a bank to invest 
such deposits in ways that would make early payment 
of depositors impossible. At any time depositors may 
lose confidence in the stability of a bank and demand 
the sums due them. Let us suppose that such a panic 
of the depositors or ''run on the bank" occurs, and that 
the bank has invested the funds intrusted to it in sub- 
urban real estate. This property may not be salable, 
and all the bank can do is close its doors until such time 
as it can dispose of its real estate holdings and pay off 
its depositors. This would, of course, mean the ruin of 
the bank, even though the real estate sold eventually 
at an advance. 

The bank may invest the funds deposited with it 
in government bonds. These always find a market, but 
their price fluctuates, and the bank might incur some 
loss in disposing of its holdings in order to meet the 
pressing demands of its depositors. Moreover, such 
bonds yield a very low rate of interest. 

The notes that are created in ordinary commercial 
transactions are one of the most satisfactory forms of 
bank investments. They are usually drawn for brief 
terms — thirty, sixty, or ninety days — and such notes 



FINANCIAL INSTITUTIONS: THE BANK 349 

are usually given in payment for goods which are 
salable in a reasonable time. Thus there is reason 
for believing that the notes can be met when due. If 
the depositors of a bank press for payment, so that the 
bank cannot await the maturity of the notes it holds, 
it can usually sell them to other banks and thus secure 
the means of immediate payment. 

In the United States national banks are limited by 
law to such investments as short term notes, bills of 
exchange, and government bonds. Investments in real 
estate, except for use in connection with the business 
operations of the bank, are prohibited. State banks are 
also more or less narrowly restricted in their investments. 

11. Under modern conditions the greater part of the 
volume of hank deposits arises out of the 
process of making loans. 

It has been assumed, in the foregoing sections, that 
the principal business of a bank is the lending of de- 
posits intrusted to it in the form of spare cash. It is 
only under simple conditions that this is a fair repre- 
sentation of the business of a bank. In a modern indus- 
trial and commercial city the deposits of cash represent 
a very small part of the volume of deposits that figure 
on the books of a bank. 

Let us suppose that a bank commences business with 
a capital of $100,000, consisting entirely of cash. Part 
of this sum — ^ say $10,000 — ^is spent in acquiring a 
suitable building. The remaining $90,000 is held in the 
safe of the bank, to be loaned to business men who can 
offer adequate security. 

A manufacturer offers at the bank acceptable notes 
amounting to $10,000, and gets them discounted. He 
may, if he chooses, carry away with him the cash repre- 
sented by the discounted value of the notes. This, how- 
ever, he is not likely to do. What he wants the money 



3 so INTRODUCTION TO ECONOMICS 

for is to make purchases of materials, to pay salaries 
and wages, and to meet other business expenses. The 
most convenient method of payment is by checks drawn 
on the bank. So instead of carrying the money away 
from the bank he is likely to leave it as a deposit, sub- 
ject to withdrawal on demand. Of course there is no 
reason why the bank should go through the form of 
counting out the cash to the manufacturer if it is to be 
redeposited in this way. What it does is to credit the 
manufacturer with a ''deposit" equal to the discounted 
value of the notes which he has transferred to it. 

Let us follow in imagination the history of the manu- 
facturer's deposit. In the course of a month he may draw 
in payment of wages and other expenses checks aggregat- 
ing a sum equal to the deposit credited to him. These 
checks may be redeposited with the bank by the manu- 
facturer's employees and the merchants who furnish 
materials and other supplies. The employees and mer- 
chants draw checks upon the bank to cover their ex- 
penses, but these checks may also be redeposited. It 
is possible that the notes originally discounted will fall 
due and be paid before the bank is compelled to sur- 
render any considerable amount of cash on account of 
the loan which it made in discounting the notes. 

Let us suppose that the bank has discounted notes 
amounting to $90,000 — a sum equal to its original cash 
holdings. In discounting these notes the bank has 
credited its customers with deposits amounting, we will 
say, to $89,000. As these deposits are drawn upon, the 
checks drawn are largely deposited with the bank under 
other accounts. Very likely not more than $4000 out 
of the $89,000 in deposits is withdrawn from the bank 
in the form of cash. We see, then, that if the bank were 
to limit its loans to the amount of cash actually on hand, the 
greater part of this cash would remain in the bank idle. 



FINANCIAL INSTITUTIONS: THE BANK 351 

Accordingly, it is natural that the bank should try to 
get a return from its cash by making additional loans. 
If it lends $200,000 on a basis of $90,000 in cash, cred- 
iting the borrowers with deposits amounting to $195,000, 
the chances are that a larger amount of cash will be 
withdrawn by depositors than if its loans amounted 
to $90,000 and the deposits to $89,000. Yet the with- 
drawals of cash may amount to only $15,000, leaving the 
bank still with a large amount of idle cash. It can safely 
increase the volume of its loans and the resultant deposits. 
As the volume of deposits increases, a point must even- 
tually be reached where the cash on hand is just suffi- 
cient to meet all probable demands. At this point the 
bank must cease to make further loans. 

12. Every hank receives in the course of its 
business checks drawn upon other hanks. 
Through the clearing system the checks 
received hy a hank are balanced against 
checks drawn upon it and deposited with 
other hanks, so that little cash is withdrawn 
from it in the settlement of claims of other 
hanks. 
One reason why a bank can extend its loans far be- 
yond the volume of the cash in its possession is that 
checks drawn upon it are likely to be deposited with it, 
instead of being cashed. If checks drawn upon one bank 
are deposited with another bank, withdrawal of cash 
would appear to be inevitable, since one bank does not, 
except under special circumstances, keep a deposit with 
another bank. 

Let us assume that in a town there are several banks 
which we may designate as A, B, C, etc. Some of the 
citizens of the town will deposit their funds with bank 
A, some with B, some with C. Often a man will use 
his check, drawn on bank A, in making a payment to 



352 INTRODUCTION TO ECONOMICS 

a man who keeps his deposit with bank B or C. The 
recipient of the check might of course take the check to 
bank A, obtain cash for it, and deposit the money with 
his own bank. It is more convenient, however, for him 
to transfer the check, by indorsement, to his own bank. 
The bank then credits him with the sum represented 
by the cheeky and assumes the trouble of collecting 
the sum from bank A. And so every day, we may 
suppose, checks drawn on bank A are deposited with 
banks B and C; checks drawn on these banks are 
deposited with bank A. At the end of each business 
day a clerk in the employ of bank A takes the checks 
drawn on B and C and presents them for payment at 
those banks. Similarly a clerk from bank B presents 
for payment checks deposited with that bank, drawn 
upon A and C. One can easily see that such a method 
of settlement involves some waste of energy. While a 
clerk of bank A is presenting for payment at bank B 
checks drawn upon that bank, a clerk of bank B is 
presenting for payment at bank A checks drav/n upon 
the latter bank. Money is being carried from A to B 
at the same time that money is carried from B to A. 
Obviously some method of balancing can be devised 
which will save the unnecessary labor and risk of thus 
carrying money to and fro. Especially would this be 
necessary in a large city, where there are scores of banks. 
In every important center the banks form an asso- 
ciation which provides a building or a hall known as a 
clearing house, where representatives of the several 
banks meet daily for the settlement of the claims of 
each bank upon the other banks. The claims of each 
bank upon all the others are set off against the claims 
of all the other banks upon it. When this has been done, 
it will be found that some of the banks have a balance 
in their favor, while others have a deficit to make good. 



FINANCIAL INSTITUTIONS: THE BANK 353 

Each debtor bank then pays a single lump sum repre- 
senting its indebtedness to all the associated banks; 
each creditor bank receives a lump sum representing 
the balance of its claims upon all the banks. By this 
method the transfer of cash from bank to bank is reduced 
to the lowest terms. 

13. The cash kept on hand by a hank to meet 
probable cash demands is known as the re- 
serve. The laws regulating banking require 
the banks to maintain reserves amounting 
to a certain proportion of the deposits and 
other demand liabilities. 

If banks are free to extend their loans at will, the 
amount of cash kept on hand to meet the possible 
demands of the depositors will vary according to the 
banking habits of the business community and the 
temperament of the bankers. In highly developed com- 
mercial communities, very little cash is used in effecting 
exchanges; reliance is placed almost entirely upon the 
use of checks. In such a community a bank may extend 
its loans, and the attendant volume of its deposits, 
almost without definite limit. If it keeps on hand 
$10 in cash for every $100 of deposits, it will probably 
be able to meet all cash demands without difficulty. 
Banks have been known to conduct a successful busi- 
ness with only I5 in reserve for every $100 of deposits. 

The smaller the proportion of the reserve to the 
deposits, however, the greater the chance that a bank 
will be unable to meet demands for cash from its depos- 
itors and other creditors. Failure to meet such demands 
may cause great embarrassment to the customers of 
the bank. If a man cannot draw upon his bank deposit, 
very likely he will be unable to meet his own obliga- 
tions; his creditors, in turn, are embarrassed in meeting 
their obligations, and so the evil extends in ever widen- 



354 INTRODUCTION TO ECONOMICS 

ing circles throughout the business community. The 
depositors of other banks, fearing that their banks will 
likewise fail to pay cash on demand, withdraw their 
deposits until, at times, it becomes impossible for those 
banks to continue to pay cash. 

It is natural that legislatures should attempt to reduce 
the chances of such a calamity by regulating the business 
of the banks. A favorite device is to fix by law a mini- 
mum reserve to be maintained by each bank against 
its deposits. In the United States the minimum reserves 
in national banks formerly were fixed at twenty-five 
per cent for the chief cities and fifteen per cent for 
smaller places. At present the banks are required to 
keep reserves in the federal reserve banks ranging from 
seven to thirteen per cent, besides whatever money in 
their tills that may be required to meet current demands 
for cash. 

Bank reserves, while they may be ample in ordinary 
times have often proved inadequate in times of crisis. 
If suspicion, however groundless, falls upon a bank, 
there may be a ''run," which quickly reduces the reserve 
below the legal limit and may if unchecked wipe it out 
altogether. Before the enactment of the Federal Re- 
serve law of 1 9 13 such emergencies were usually provided 
for by mutual aid among the banks. If withdrawals 
of deposits from one bank became too heavy, that bank 
would transfer some part of the notes in its portfoHos 
to other banks, receiving in return cash items to replen- 
ish its reserves. If all the banks of a given city or sec- 
tion of the country found themselves embarrassed by 
excessive withdrawals, they made similar arrangements 
with banks in other parts of the country whose reserves 
remained strong. And in times of general commercial 
crisis the banks of the country formed temporary asso- 
ciations whose object was to present a united front 



FINANCIAL INSTITUTIONS: THE BANK 355 

against panic. The force impelling to mutual aid was 
the common danger. For if one bank in a city is forced 
to suspend, the contagion of suspicion is likely to be 
transmitted to other banks and lead to heavy with- 
drawals of cash. If in time of crisis one bank failure 
after another is reported, a point is soon reached in which 
the pubHc loses confidence in all banks, and even the 
strongest incurs the risk of being deprived of its reserves 
by the run on deposits. 

It was primarily to meet this condition that the Fed- 
eral Reserve system was instituted. Under this system 
all national banks and such state banks as wish to meet 
the requirements as to reserves, etc., are grouped in 
twelve systems, each with a federal reserve bank at its 
head. This bank derives its capital from subscriptions 
by member banks, amounting to six per cent of the cap- 
ital and surplus of each bank. The principal part of the 
reserves of the member banks are kept in the federal 
reserve banks and may be drawn on when required. 
Moreover, any member bank may take notes from its 
portfolios and transfer them — ^"rediscount" them — • 
with the federal reserve bank, receiving in return credits 
to be drawn upon or bank notes with which to meet 
the demands of its depositors. So long as a member 
bank has sound paper in its portfolios, it is in no danger 
of being forced to suspend for want of currency to pay 
off its depositors. Under the Federal Reserve plan the 
banking system of the United States proved able to 
weather safely all the stresses of war and post-war 
depression. 

14. The chances of ultimate loss to the depositor 
of a well conducted hank are very small. 

It may seem that even when a bank keeps a reserve 
amounting to twenty-five per cent of its deposits, the 
depositor is in danger of loss. What if more than twenty- 



3S6 INTRODUCTION TO ECONOMICS 

five per cent of the deposits should be demanded on any 
one day? The bank would, of course, be unable to make 
payment immediately. 

If a bank is not grossly mismanaged, it has property 
worth at least one dollar for every dollar figuring in its 
deposits. When it makes a loan of $10,000, thus creating 
a deposit amounting, we will say, to $9700, it receives 
from the borrower notes amounting to $10,000, which 
must be set against the $9700 which it owes its depos- 
itors. If the notes are good, at their maturity the bank 
will receive more than enough cash to cancel the deposits 
created when the loan was made. Every part of the 
volume of deposits is covered in this way by notes, bills 
of exchange, etc., in the vault of the bank. 

These notes, etc., usually run for short periods, sel- 
dom extending over six months, and frequently maturing 
in less than thirty days. Even if the bank fails to meet 
its obligations on demand, the worst that the depositor 
usually has to fear is that he will have to wait some weeks 
or months until the bank can collect the sums due it. 

But suppose that the notes in the bank's vaults are 
worthless; that the bank will be unable to collect the 
sums due. In that case, the bank's own capital must be 
used to meet the claims of the depositors. If the vol- 
ume of worthless notes exceeds the amount of the bank's 
capital, then the depositor may suffer loss. 

It is, however, rarely the case that a bank discounts 
any large number of worthless notes. A bank accepts 
only such notes as there is reason to believe are good. 
Bank officials are in an excellent position to judge of the 
business standing of the bank's customers. Checks used 
by these customers in payment of their obligations pass 
through the bank; checks received by them are deposited 
with the bank. Thus it becomes fairly easy for compe- 
tent bank officials to ascertain whether a business man 



FINANCIAL INSTITUTIONS: THE BANK 357 

is prospering, or operating at a loss. In the latter case, 
the bank forces the payment of notes when due, and 
refuses to make new loans. Thus bank loans are, as a 
rule, restricted to those members of the business com- 
munity who are able to keep themselves in a position 
to pay their debts. 

In some instances, to be sure, banks are ruined through 
fraud. Bank ofhcials may embezzle the funds or may 
extend loans to personal friends to be employed in risky 
ventures which result in total loss. The laws of most 
states are stringent enough to reduce losses through 
fraud to a minimum. And the federal banking laws 
are so stringent as to reduce the chance of failure very 
near to zero. In 1920, for example, there were 8,019 
national banks with deposits aggregating $15,142,000,000. 
There were ten failures, with habilities aggregating 
$3,350,000. And even of this insignificant sum, a 
large part was covered by assets that could later be 
liquidated. 

15. Bank notes are claims upon the hank that 
^ are essentially of the same nature as de- 

posits. 

In the foregoing discussion it has been assumed that 
the transfer of claims upon the bank is made through 
checks, drawn upon a deposit, and redeposited by the 
holder. A man who receives a check may, however, 
transfer it, properly indorsed, to another man, who in 
turn may transfer the check to a third person. Each 
holder of the check becomes in turn the creditor of the 
bank. When the check is at last deposited with the bank, 
the claim upon the bank is formally transferred on its 
books. But it is obvious that the claim on the bank is 
just as certainly transferred whenever the check changes 
hands. 

Such a check could not pass through many hands, be- 



358 INTRODUCTION TO ECONOMICS 

cause only those persons knowing the credit of the drawer 
would be willing to accept it. There are men who draw 
checks on banks where they keep no deposit; if you are 
offered a check drawn by some one you have never heard 
of, how do you know that it will be honored by the bank? 

A person wishing to use checks as a means of payment 
among persons who are not certain of his credit may 
take the checks to the bank and have the cashier cer- 
tify upon their face that they represent a deposit, and 
will be honored by the bank. Such checks — ^ known as 
certified checks — may circulate as freely as money in 
the community where the bank's standing is known. 
It is clear, however, that a certified check is a claim upon 
the bank of the same nature as an ordinary check drawn 
upon a deposit. 

Instead of certifying checks drawn upon a deposit, 
the bank may give the customer who wishes means of 
ready payment a parcel of its own notes, payable to the 
bearer on demand. The customer is then the creditor 
of the bank for the amounts stated in the bank notes 
in his possession. As soon as he uses the notes for the 
purchase of supplies, etc., he transfers the claim upon 
the bank to the seller of the supplies. Such notes may 
pass from hand to hand for years, each successive holder 
of a note becoming the creditor of the bank. 

Obviously it makes little difference to the bank whether 
a business man who discounts a note is credited with a 
deposit on the books of the bank or takes the bank's 
notes in the same sum. The deposit represents a right 
to cash on demand; the bank notes represent exactly 
the same thing. The deposit may pass from owner to 
owner through checks drawn upon it and redeposited 
with the bank; the note passes from owner to owner 
without the formality of a transfer on the books of the 
bank. Any one of the series of owners of the deposit 



FINANCIAL INSTITUTIONS: THE BANK 359 

may demand cash at any time; the same is true of any 
one of the series of holders of a bank note. For some 
classes of transactions, it is true, a deposit subject to 
check is the more convenient means of payment, while 
for other classes of transactions bank notes are the 
more convenient. 

16. The issue of hank notes is usually hedged 
about by legal restrictions designed to 
protect the note holder from loss. 

The issue of bank notes is usually carefully regulated 
by government, so as to safeguard the holder of notes 
against loss. Now, we have seen that the positions of 
the note holder and the depositor are analogous. Both 
are creditors of the bank; both have a right to cash on 
demand. Why then should the government take greater 
pains to insure the note holder against loss than to insure 
the depositor? 

The depositor usually Hves in the city in which the 
bank which holds his funds on deposit is established. 
He is therefore in a position to know something of the 
standing of the bank. If he has reason to believe that 
the bank is not well managed, he can at once withdraw 
his deposit. On the other hand, bank notes often find 
their way to distant cities. The holders of such notes 
can know nothing about the credit of the issuing bank. 
For this reason it is only just that their interests should 
be protected by the government. 

Various methods are employed by the different gov- 
ernments to protect the note holder against loss. In 
some countries the volume of notes that a bank may issue 
is limited to a certain proportion of the capital of the 
bank; in case of failure the note holders have a prior 
claim upon all the resources of the bank; furthermore, 
each bank is required to contribute to a fund for the 
immediate payment of notes of banks that have failed. 



36o INTRODUCTION TO ECONOIMICS 

In the United States the privilege of note issue is prac- 
tically restricted to national banks; other banks may 
indeed issue notes, but are taxed so heavily on their notes 
that issue is unprofitable. A national bank which avails 
itself of the privilege of issue must purchase, and deposit 
with the United States Treasury, United States bonds 
the par value and the market value of which is equal 
to the value of the notes issued. In case the bank 
fails, these bonds are sold, and the proceeds used to 
redeem the notes. Thus it is quite impossible for the 
holder of bank notes to suffer loss, even if the bank 
of issue fails. 

Besides the ordinary national bank note we have in 
circulation two other kinds of notes, the federal reserve 
bank note and the federal reserve note. The federal 
reserve bank note is secured, like the national bank 
note, by government bonds deposited in the treasury 
by the federal reserve bank. The federal reserve notes 
are issued on the basis of ordinary commercial paper, 
rediscounted with the federal reserve banks. But the 
credit of these notes is supported by all the assets of 
the federal reserve banks and ultimately by that of the 
whole system. Only a universal financial disaster could 
destroy the value of these notes. 

17. Bank notes and hank deposits serve as 
currency, and reduce the amount of money 
needed for effecting exchanges. 

In the United States bank notes are used in effecting 
exchanges in the same way that money is used. Every 
one knows that the note holder is absolutely insured 
against loss; consequently no one takes the trouble to 
present bank notes at the issuing bank for redemption 
in money. Were the issue of bank notes prohibited, a 
large volume of exchanges now effected through their 
use would have to be effected by means of money. We 



FINANCIAL INSTITUTIONS: THE BANK 361 

should need a much larger amount of money than we 
now possess to carry on the existing business of the 
country. 

Bank deposits serve in a similar way as a means of 
effecting exchanges. A deposit, we have seen, is not 
a definite sum of actual money, kept safe in the vaults 
of a bank. It is a right to demand money at the bank. 
When a man pays for goods by means of a check drawn 
on such a deposit, he simply transfers his claim upon the 
bank. Such a claim may be transferred again and again, 
effecting scores of exchanges. 

It has been estimated that in the great commercial 
centers of the United States fully ninety-five per cent 
of the total volume of purchases and sales is effected 
by means of the transfer of claims upon banks. Money 
plays a relatively more important part in the lesser towns 
and the rural districts; yet even here bank notes and 
deposits effect a larger volume of exchanges than does 
actual money. 

18. Summary. 

The principal function of finance is the transfer of 
capital to those who can use it most advantageously. 
The transfer of capital . most frequently assumes the 
form of a loan, either recognized as such, or disguised 
under the form of a credit sale. We may look upon the 
lending of capital as the purchase of such credit instru- 
ments as the promissory notes given by borrowers. 

The function of the bank is primarily the borrowing 
of sums of capital available for short periods of time 
and the investment of such sums in short term credit 
instruments. The sums borrowed by the bank are known 
as "deposits"; the investments of the bank, since they 
represent for the most part the face value of the credit 
instruments purchased, less interest to maturity, are 
known as "discounts." In practice, when a business 



362 INTRODUCTION TO ECONOMICS 

man sells a note to a bank, he leaves the proceeds of the 
note as a "deposit" in the bank, subject to withdrawal 
by check. In modern banks by far the greater part of 
the volume of deposits is created in this way, and not by 
the deposit of cash. 

While the bank is compelled to pay out its deposits 
on the demand of the depositor, it is rarely the case 
that many depositors demand cash at any one time. 
This is partly due to the convenience of payment by 
means of checks. A depositor who wishes to make a 
payment draws a check in favor of his creditor; and 
this check is likely to be deposited in the bank by the 
payee; thus the payment is effected without any with- 
drawal of cash from the bank. The system of clearing 
protects each bank against serious drains upon its 
cash holdings through checks drawn upon it and depos- 
ited in other banks. 

While Httle cash is withdrawn from a bank under 
ordinary circumstances, it is nevertheless necessary for 
a bank to keep on hand a considerable amount of cash, 
to safeguard itself against unexpected demands. The 
cash thus kept on hand is known as the reserve. The 
amount of the reserve should bear a proportion to the 
deposits which varies according to the character of the 
community in which the business is carried on. In the 
United States a minimum reserve is prescribed by law. 
The ultimate solvency of a bank does not depend upon 
its reserve, but upon the character of the notes in which 
the bank invests its funds. These are, as a rule, sound, 
and the chances of bank failure, except through fraud, 
are small. 

The notes issued by banks are demand liabilities not 
essentially different from deposits. Since notes wander 
far from the bank of issue and are offered in payment to 
persons who can know nothing of the credit of the 



FINANCIAL INSTITUTIONS: THE BANK 363 

issuing bank, special regulations are adopted by gov- 
ernments to insure their payment. 

Bank notes and bank deposits fulfill the functions of 
currency. The amount of money necessary for carrying 
on exchanges is greatly reduced by the use of a deposit 
and note currency. 



CHAPTER XVIII 
OTHER FINANCIAL INSTITUTIONS 

1. The making of permanent and long term 

investments may he regarded as the flow of 
funds from the capitalist class to the 
enterpriser class. 
The chief function of the bank, as we have seen, is 
the supplying of the demand for short term loans, through 
the accumulation and placing of capital which is avail- 
able for use for short periods of time. The creditors of 
a bank and its debtors are, as a rule, members of the 
same economic class — men actively engaged in trade 
and industry. Each man is, in turn, borrower and lender. 
In the present chapter we are "concerned with the invest- 
ment of funds in credit instruments that run for long 
terms, or are perhaps even perpetual. It is plain that 
we are here dealing with the relations of two fairly dis- 
tinct economic classes. Men who, for one reason or 
another, take no active part in business, place their 
funds with active business men. The former class 
corresponds roughly with the capitalist class of economic 
theory, the latter, with the enterpriser class. We may, 
therefore, regard the placing of capital in permanent and 
long term investments as a flow of funds from the 
capitalist to the enterpriser. 

2. The principal sources of demand for long 

term investment funds are (i) the purchase 
and improvement of real estate; (2) the 
financing of large corporations; and (3) 
the extraordinary needs of government. 
Throughout the country there is a constant demand 
for capital for the purchase and improvement of real 

364 



OTHER FINANCIAL INSTITUTIONS 365 

estate. Men with small capitals of their own desire to 
buy farms or building lots; men who possess land desire 
to prepare it for cultivation or to equip it with the 
necessary stock or buildings. Those with insufficient 
capital — and they are many — enter the capital market 
as borrowers. They expect such capital as they may 
raise through loans to be productive, but they cannot 
be sure that they will be able to restore it to the lenders 
for several years. To meet the needs of such borrowers, 
lenders must surrender control of their funds for a con- 
siderable period of time — five, ten, or fifteen years. 

A second source of demand for capital arises from the 
needs of the modern large scale business enterprise. In 
many forms of business the capital necessary for effective 
operation exceeds the amount that an ordinary enter- 
priser owns, or can raise through personal loans. The 
number of million-dollar enterprises in the United States 
vastly exceeds the number of millionaires. Accordingly, 
it is necessary to transfer to a single active enterpriser 
the capitals accumulated by numerous individuals. 

A third source of demand for capital — and the last 
with which we need concern ourselves — arises from the 
extraordinary needs of government. Under ordinary 
conditions the expenditures of most governments are met 
by current revenues. Owing to unforeseen circumstances, 
revenues may be less than were anticipated, while ex- 
penditures may prove unusually heavy. As it takes time to 
revise a revenue system, a considerable deficit may appear, 
which involves borrowing under one form or another. 

A much more important cause of public borrowing is 
the enormous expense entailed by modern warfare. No 
great war can be carried to a successful issue without 
the employment of far greater resources than any prac- 
ticable system of taxation will afford. Recourse must 
therefore be had to loans. Government loans thus 



366 INTRODUCTION TO ECONOMICS 

arising cannot quickly be paid off. Often loans are 
negotiated for ten, twenty, or thirty years; and even 
at the expiration of the period for which they are con- 
tracted, they are frequently paid out of the proceeds of 
new loans. Before the outbreak of the Great War most 
of the debt of the United States was a legacy from the 
Civil War; much of the debt of Great Britain originated 
in the wars of Napoleon. Large as those debts seemed 
in 1914, they have been wholly dwarfed by the debts 
created in the course of the Great War. In many Euro- 
pean countries the debts exceed all practical possibility 
of repayment. That is not true of the debt of the 
United States or even of that of Great Britain. But 
there is no probability that the American debt will be 
paid off within a generation, nor that the British debt 
will be visibly reduced in that period of time. 

Again, governments may borrow money for the pur- 
pose of carrying out a policy of permanent improvements. 
The United States, for example, raised the funds for the 
construction of the Panama Canal through loans. Before 
the war European governments borrowed vast sums for the 
purpose of purchasing and constructing railways. Cities are 
continually borrowing money for similar purposes. Es- 
pecially where the policy of municipal ownership finds 
favor, the demand for capital for pubHc use is enormous. 
3. The principal sources of supply of capital for 
long term investments are: (i) private 
fortunes accumulated in business, whose pos- 
sessors desire freedom from the labors of 
active management; (2) the funds of endowed 
institutions; (3) the funds accumulated from 
private incomes and kept as a reserve 
against contingencies. 
Just as there are always men who are entering bus- 
iness life, so there are always men who are retiring from 



OTHER FINANCIAL INSTITUTIONS 367 

active business affairs. Men of the latter class desire 
to obtain an income from their accumulations without 
the labor that personal management entails. Univer- 
sities, hospitals, and other institutions receive money 
endowments, which must be invested in such a way as 
to yield a steady income. Wage-earners and pro- 
fessional men are under the necessity of putting by a 
part of their incomes as a reserve against sickness and 
old age, or as a provision for their dependents in case 
of death. Capitalists who look forward to increasing 
burdens save part of their interest receipts; active 
business men save part of their profits. Of these savings 
some part is reinvested in their own business by the men 
who save. A great part of the total fund of savings 
must, however, be placed under the control of other 
persons, if it is to yield a considerable income. 

We have now a view of the work that the financial 
mechanism must perform. It must gather together the 
funds of free capital and place them under the control 
of those who can make best use of such funds. We 
may next proceed to a study of the methods by which 
this work of placing capital is performed. 

4. The typical instruments employed in the 
effecting of long term and permanent invest- 
ments are mortgage notes, bonds, and stocks. 

The transfer of capital for long terms implies the 
creation of various instruments which serve as evidence 
of the claims of the capitalist. The simplest type of 
such instruments is the promissory note secured by the 
pledge of property, such as houses and lands. Where 
the sum to be raised by a loan is very great, as in the 
case of corporation loans, the resources of numerous 
lenders must be drawn upon. Instead of executing a 
great number of separate notes, representing the amount 
borrowed from each person, the corporation may exe- 



368 INTRODUCTION TO ECONOMICS 

cute a note, secured by the pledge of property, covering 
the whole sum, and deposit it with a trustee. The 
trustee then prepares certificates representing shares 
in the loan, and delivers them to lenders as evidence 
of the sums loaned. Such certificates are known as 
''bonds." A government may issue similar certificates 
of indebtedness without executing a note representing 
the entire loan. Such bonds are seldom secured by the 
pledge of property. In any case it is clear that gov- 
ernment and corporation bonds are merely forms of 
promissory notes. 

Instead of raising money through an issue of bonds, 
a corporation may sell shares of stock which entitle the 
owner not only to an income, but to a share in the 
management of the enterprise. In law the position of 
the stockholder is very different from that of the bond- 
holder. The former is a partner in the business under- 
taking; the latter is a creditor of it. In practical hfe 
the ordinary stockholder has httle to do with the control 
of a corporation. He purchases stocks for the income 
they yield, just as he would purchase bonds for their 
income. The bondholder is a preferred claimant; there- 
fore bonds, as a rule, offer a more certain income. The 
different classes of bonds vary widely in security, how- 
ever, and many are inferior to certain classes of stocks 
in this respect. 

Such instruments — promissory notes, bonds, and 
stocks — are clearly not capital, but merely evidence 
of ownership of capital. We may, however, think of 
the purchase and sale of such instruments as the pur- 
chase and sale of capital, since the ownership of the 
underlying productive goods is transferred with the trans- 
fer of such instruments. For convenience we may speak 
of notes, bonds, and stocks as ''investments." Bonds 
and stocks are commonly called ''securities." 



OTHER FINANCIAL INSTITUTIONS 369 

5. Investments vary greatly in respect to security. 
Investments of this character, as has been said, differ 

widely in security. The long term notes of business men 
are usually secured by the pledge of tangible property 
of some kind, but the property pledged may represent 
a more or a less adequate guaranty of repayment. A 
loan secured by the pledge of land in a semi-arid region 
is not so safe as a loan secured by the pledge of land 
in a locality where crop failures are unknown. A series 
of dry years may depopulate the semi-arid district, and 
practically destroy the value of land there. Loans secured 
by suburban real estate are not, as a rule, so safe as loans 
secured by business property in the heart of a city. The 
bonds of a government like that of the United States 
are to-day generally regarded as safer investments than 
those of Great Britain; the bonds of the latter country 
are regarded as safer than those of France, Belgium or 
Italy. Corporation bonds similarly vary widely in 
security. Experience has shown that corporations fre- 
quently become bankrupt, and in such cases the bond- 
holders may lose part or all of their invested capital. 
Stocks, as a rule, are yet more uncertain investments. 
When a new interurban railway is constructed, no one 
knows certainly that the business which it will carry on 
will yield a fair return bn the capital invested; if it 
does not do this, dividends on its stock will be low. 
Even in the case of an established business, changed 
conditions may annihilate profits and cause a suspension 
of dividend payments. 

6. Investments vary in their transferability. 

Suppose that an investor in New York holds a note 
secured by a mortgage on a farm in one of the western 
states. In some of the states such a note is not trans- 
ferable at all. Even if the laws are such as to permit the 
sale of the note to a third party, the holder would find 



370 " INTRODUCTION TO ECONOMICS 

difficulty in disposing of it. The buyer would need to 
know something of the value of the property pledged 
as security and this he might be unable to ascertain 
without examining it himself. The bonds of a small 
manufacturing or mercantile corporation in one of the 
minor cities would more easily find buyers in distant 
financial centers. Even these, however, would ordinarily 
be difficult to dispose of. The bonds of a great railway 
or of an industrial consolidation always find a ready 
sale. One who invests in a Pennsylvania Railway or a 
United States Steel Corporation bond knows that he 
can at any time find some one who will be ready to buy 
it from him. 

7. The productiveness of an investment is measured 
by the ratio between its return and its market 
value. Different classes of investments vary 
widely in productiveness. 

It is, perhaps, straining the meaning of words to 
speak of a mortgage note or a corporation bond as 
being '' productive." There is, however, reason to dis- 
tinguish between the securities that yield an income and 
those that yield none, and the business world has drafted 
the words ''productive" and "unproductive" into this 
service. We may safely accept the terms, as we are in 
no danger of falling into the ' error of regarding notes 
and bonds as actually productive, in the physical sense 
of the term. 

We must distinguish between nominal productiveness 
and real productiveness. A bond of $ioo face value 
may yield $4 per annum. The nominal productiveness 
of capital invested in such a bond is four per cent. 
But perhaps the bond may be purchased in the market 
for $80. In such case the real productiveness of capital 
invested in the bond is five per cent. A $100 share of 
stock paying dividends of ten per cent on its par value 



' OTHER FINANCIAL INSTITUTIONS 371 

may sell at $200. The real productiveness of capital 
invested in such a stock is no greater than that of 
capital invested in the four per cent bond. 

We need not concern ourselves here with nominal pro- 
ductiveness. Whether such productiveness is high or 
low is a matter dependent upon the volume of securities 
covering a specific earning power, and this volume is 
arbitrarily fixed. Real productiveness varies widely. 
Some investments yield only two per cent; some yield 
ten per cent or even more. 

8. The principal cause of variation in the pro- 
ductiveness of investments is risk, real or 
imagined. 

The bonds issued by the United States government 
yield only a Httle over three and one half per cent on 
the capital represented by their market value. Bonds 
issued by the government of Santo Domingo, before 
the time of American intervention in the affairs of that 
country, often yielded as much as twelve per cent on 
their market value. Practically the only reason for the 
great difference in productiveness was the difference in 
security. The bonds of the several states vary consid- 
erably in productiveness, and the bonds of municipal- 
ities display yet greater variety. The greatest variations 
in productiveness are to be found in corporation stocks, 
for here risk is greater than in the case of most classes 
of bonds. 

Although there may be no real difference in risk be- 
tween two investments, if it is commonly believed that 
there is such a difference, this belief is reflected in the 
productiveness of the respective investments. The bonds 
of Japan may be as safe as those of the United States; 
but this is not generally believed to be true. For this 
reason investments in Japanese bonds are more produc- 
tive than investments in United States bonds. 



372 INTRODUCTION TO ECONOMICS ' 

9. The productiveness of investments varies with 

their degree of transferability. 

As a rule, the greater the transferability of a form 
of investment, the lower will be its productiveness. 
Few investors are absolutely certain that they will not 
at some time desire to regain control of their funds. 
They will therefore take at par a bond that is easily 
disposed of rather than one of equal security and equal 
nominal productiveness which they might find difficulty 
in selling. Consequently, the price of bonds of the for- 
mer class will generally be higher than that of bonds 
of the latter class. A hundred dollars invested in the 
former class of bonds will yield a lower rate of interest 
than a hundred dollars invested in the latter class. 

The bonds of a great industrial corporation are usually 
less productive than those of a small one, on account 
of the greater transferability of the securities of a well- 
known business concern. Most classes of bonds furnish 
less productive investments than small real estate mort- 
gages, because the latter can be transferred only with 
difficulty. 

10. The placing of capital may he efected by 

direct arrangements between the capitalist 
and the enterpriser or through the interme- 
diation of a broker or other middleman. 
Where economic conditions are simple, as in an agri- 
cultural district or in a small town, the placing of capital 
may be effected through direct arrangements between 
those who need capital and those who have it to spare. 
The moral character and business capacity of an enter- 
priser is easily ascertained by those who wish to place 
their capital. A man who wishes to borrow capital can 
easily establish relations with those who have capital 
to lend. Even in such simple conditions, however, the 
individual borrower or lender is often at a disadvantage. 



OTHER FINANCIAL INSTITUTIONS 373 

The former may fail to meet the men who are ready to 
lend at the lowest interest rate; the latter may fail to 
find the safest and most productive investments for his 
capital. Hence the need for a middleman, to bring 
together borrower and lender, enterpriser and capitalist. 
As industrial conditions become more complex, the need 
for the middleman becomes more intense. It would 
be quite impossible for the small capitalist of a city Hke 
New York or London to search out the most produc- 
tive investments afforded by the business of such a city, 
were there no men who made it their business to bring 
capitalist and enterpriser together. 

The men who perform this function may employ 
either of two methods. They may act as mere agents, 
in behalf of lender or of borrower or of both. Thus in 
some towns there are men who undertake, for a fee or 
^'commission," to place any man who wishes to borrow 
in relations with men who have capital to lend. The 
function may, however, be performed in another way. 
Men with some capital of their own may hold themselves 
in readiness to borrow any capital that is offered for a 
definite period of time, trusting to the chance that they 
will be able to lend it again on more advantageous 
terms. The difference between the interest received and 
the interest paid represents the profits of the middleman. 
This, we have seen, is the method employed by the bank 
in its Droper field. 

The distinction which we have drawn between the 
two methods of placing, or marketing, capital, finds its 
analogue, we readily see, in a similar distinction in the 
methods of marketing commodities. A manufacturer 
may employ an agent, at a fixed commission, to bring 
his wares before the consuming pubKc, or he may sell 
them to a merchant, who undertakes the responsibihty 
of disposing of them to consumers. 



374 INTRODUCTION TO ECONOMICS 

11. In the great modern commercial centers the 

placing of capital is effected largely through 
the stock exchanges — markets for the pur- 
chase and sale of securities. 
Under modern conditions an enormous amount of 
capital is represented by the bonds of nations, states, 
and municipalities and of private corporations, as well 
as by the stocks of corporations. A government may 
issue several hundred millions in bonds, all yielding the 
same return and having the same security, and private 
corporation issues of bonds and stocks are sometimes of 
equal magnitude. A person wishing to invest in a 
particular issue of government or corporation securities 
leaves an order with a broker to purchase such securities 
for him. A person wishing to regain control of capital 
invested in securities leaves them with a broker with 
orders to sell them. Naturally, the brokers deahng in 
stocks and bonds establish the custom of meeting at a 
fixed place, where those who have orders to buy may 
meet those who have orders to sell. Such a meeting- 
place, or market, is known as a stock exchange. For 
convenience, each exchange makes rules which brokers 
doing business there must observe. In their details these 
rules do not concern us here; in principle they are 
designed to insure effectiveness and fair dealing. 

12. Since securities dealt in on the exchanges 

fluctuate in value, profits may be secured 
through buying when such securities are 
cheap and selling them when dear. 
Business of this nature is termed speculation. 
Practically all the securities dealt in on the exchanges 
are constantly fluctuating in price. The bonds of a 
country like the United States are unusually stable in 
value, yet a hundred-dollar bond is somewhat cheaper 
at one time than at another. When a nation becomes 



OTHER FINANCIAL INSTITUTIONS 375 

involved in a war, the price of its bonds declines, because 
of the probability of vast new issues and the possibility 
that the war will drag on to the point of bankrupting 
the nation. Even the rumor of a war, however slight 
its foundation, may affect adversely the price of a 
nation's bonds. The bonds of a city may decline in 
value if the city government announces its intention of 
undertaking improvements on a large scale, or if it falls 
under the control of an extravagant administration. 
The price of bonds of railway and industrial corporations 
is affected by every change in business conditions. Price 
fluctuation is still more common in the case of stocks. 
It is not unusual for the price of a given stock to decline 
from $150 per share to $60 per share within a single 
year. Suppose that a company has been formed to ex- 
ploit gold mines in Alaska. Its shares are offered on the 
market; we have read glowing accounts of the prospects 
of the company, but whether these accounts are reliable 
or not we cannot say. The company may earn enough 
to pay enormous dividends; it may earn nothing. What 
is more natural than that opinion as to the value of the 
stock should fluctuate accordingly? 

In view of the constant fluctuation in securities, it is 
natural that some men should make it their business to 
buy stocks when they appear to be cheap, with the 
purpose of selling them when prices rise. This is one of 
the numerous forms of speculation. The buyers of stocks 
and bonds are commonly divided into two classes — 
investors and speculators. The former class buy chiefly 
with the purpose of enjoying a permanent income from 
the securities purchased; the latter, chiefly with the hope 
of profiting from a rise in price of the securities. 



376 INTRODUCTION TO ECONOMICS 

13. The speculator provides enterprises which 
have not yet demonstrated their power to 
yield an income with the capital necessary 
for carrying on business. 

Naturally, the speculative buyer deals commonly in 
the securities that show great fluctuations in price, while 
the investor prefers the securities that have a compar- 
atively steady price. Now, it is the securities of new 
companies that are most likely to fluctuate in value. 
After a company has been in operation for a number of 
years, its normal earning power becomes established, 
and the real value of its securities becomes fairly well 
settled. Thus there is a constant progress of securities 
from the speculative class to the investment class. 

We can now see what one of the economic functions 
of stock speculation must be. So long as the success of 
a company is in doubt, the cautious investor will have 
nothing to do with it. Men who are willing to take risks 
— speculators — buy the securities of such a company, 
with the expectation of selling them later at a profit. 
In so doing they furnish the company with the funds 
necessary for carrying on business operations. If the 
company succeeds, and demonstrates its power to pro- 
duce a large and steady income, its securities acquire 
a stability of value fitting them for purposes of per- 
manent investment. The speculators, in such cases, 
gain large profits. If the company is a failure, the 
speculators bear the loss. 

It is of course true that stock speculation offers great 
opportunities for sharp practice. A group of speculators 
holding the stock of a gold-mining company may succeed 
in placing in circulation deceptive accounts of the pros- 
pects of the company, and so manage to dispose of their 
holdings to the unwary at unreasonably high prices. 
A group of speculators, desiring to purchase certain 



OTHER FINANCIAL INSTITUTIONS 377 

stocks at a low price, may circulate rumors of impending 
disaster, and so create a panic among holders of stocks. 
Nevertheless, it is to be borne in mind that the specula- 
tive buyer of stocks performs a very important economic 
function in furnishing capital for enterprises the success 
of which is still in doubt, but which may eventually 
prove to be highly profitable. The speculator stands in 
the position of a middleman between the company which 
needs capital and the cautious investor. 

14. When a company seeks to raise capital through 
an issue of securities, it may place orders 
with brokers to sell the securities for what 
they will fetch, or it may make, with an 
association of financiers, an agreement 
according to the terms of which the asso- 
ciation assumes responsibility for the sale 
of the securities at a definite price. Such 
an association is called an underwriting 
syndicate. 
Let us suppose that a great railway desires to raise 
about $50,000,000 by a new issue of five per cent bonds. 
It may place orders with brokers to sell the bonds at 
whatever price they will command. The bonds of the 
railway which are already outstanding may be selling 
above par, but no one can say exactly what effect on the 
price of bonds the new issue will have. Possibly the 
bonds will be taken by investors at par; possibly the 
, price will fall to $85 per hundred dollar bond. Moreover, 
it may take a long time before all the bonds are taken by 
speculators or investors. The railway company, however, 
desires a definite amount of capital at a definite time, and 
cannot afford to experiment. So its agents may make an 
arrangement with a group of financiers whereby the latter 
agree to insure the sale of the entire issue at $95 per hun- 
dred dollar bond. The bonds are then placed on sale at. 



378 INTRODUCTION TO ECONOMICS 

say, $100. If the investing public takes the bonds at this 
price, the group of financiers, or ''underwriting syndi- 
cate," gains a profit equal to the difference between the 
price to the pubhc and the price agreed upon between the 
railway company and the syndicate. If the public re- 
fuses to buy, the syndicate is compelled to take the issue 
of bonds at the price agreed upon — $95. Possibly the 
syndicate will be able to dispose of the bonds later on 
favorable terms; possibly it will in the end be compelled 
to sell them at less than the price it has paid. 

Where the securities underwritten by a syndicate are 
of a more speculative character, as for example the stocks 
of a new industrial corporation, the difference between the 
price placed upon securities offered to the public and the 
price to the syndicate is much greater. The possible prof- 
its of the syndicate are much greater; but so also are 
the possible losses. 

15. An investment company is a company which 
purchases and holds stocks, bonds, mortgages, 
etc., the income of which is distributed as 
dividends among its own shareholders. 
A company may be formed for the sole purpose of 
dealing in the securities of other companies. Such a 
company — which we may call an investment company — 
places its stock upon the market, and invests the proceeds 
of the sales of such stock in the stocks and bonds of bank- 
ing, railway, franchise, and industrial corporations, in 
government bonds, or in real estate mortgages. The in- 
terest and dividends from such investments make up the 
gross profits of the investment company. From these 
profits are deducted the expenses of administering the 
company; the remainder may be distributed among its 
stockholders as dividends. The advantages of such a 
company are obvious. It can employ men who are thor- 
oughly famiHar with the securities market to purchase 



OTHER FINANCIAL INSTITUTIONS 379 

stocks and bonds when the condition of the market is 
favorable. Since it purchases on a larger scale than the 
ordinary investor, it may participate in underwriting syn- 
dicates, and so obtain securities at a lower price than the 
outside investor must pay. It may distribute its invest- 
ments so that when some of them fail to yield the ex- 
pected returns, others may yield unusually large returns. 
Thus the stockholders of the investment company are 
made more certain of a steady income than they would be 
if they invested their funds directly. 

Further, the investment company may deal in securi- 
ties of undoubted value, which are nevertheless not well 
enough known to be easily transferred. There is no rea- 
son why the investment company should ever part with 
such securities. It may purchase mortgage notes which 
never would find a purchaser on the general market. As 
we have seen, the non-transferable investments yield, as 
a rule, higher returns than those that are easily trans- 
ferred. Accordingly, the man who invests his funds 
through an investment company enjoys the higher income 
that non- transferable investments yield; at the same 
time, he can at any time regain control of his funds 
through the sale of his stock in the investment company. 

16. The savings hank performs the same function 
for the small investor that the investment 
company performs for the large one. 

It is only persons possessing at least a moderate amount 
of free capital who can purchase with advantage invest- 
ment company shares. Persons who have no other re- 
source than their daily labor need to save some part of 
their income against sickness, old age, or unemployment; 
and these savings should be placed where they may at 
once begin to earn interest. The artisan who saves $5 a 
month cannot be expected to keep the money on his 
premises until he has accuniulated enough to buy a share 



380 INTRODUCTION TO ECONOMICS 

of stock. This would involve keeping part of his savings 
idle for perhaps twenty months. It would, moreover, 
expose such savings to the recurrent temptation to spend. 
Hence the need of an institution which will accept savings 
deposits, however small, paying interest on them from the 
beginning, and which will return them to the depositor 
upon reasonable notice. Such an institution is the savings 
bank. 

Unlike the commercial bank, described in the last chap- 
ter, the savings bank can depend upon a certain perma- 
nence of deposits. Men who intrust their funds to such 
an institution do so, as a rule, with the expectation of 
leaving them for an indefinite time, to earn interest. The 
rules under which a savings bank operates may of them- 
selves insure a reasonable degree of permanence of de- 
posits. Depositors are often required to give some days' 
or weeks' notice of intention to withdraw deposits. Fur- 
thermore, interest is usually allowed only at the end of 
six months' periods; withdrawal at any time within such 
periods involves the forfeiture of accrued interest. 

Some part of the deposits of a savings bank must be 
kept as a cash reserve, to meet possible withdrawals, but 
this reserve need not be large. The remainder of the de- 
posits may be invested. State laws generally specify the 
classes of investments that a savings bank may make, 
with a view to insuring the depositor against loss through 
insecure investments. Real estate mortgages, federal, 
state, and municipal bonds, are the favorite investments 
of such institutions. The real estate mortgages present 
the advantages of security and high degree of product- 
iveness; government bonds, while yielding low returns, 
are easily convertible into cash whenever an unusual vol- 
ume of withdrawals renders this necessary. 

Savings banks may be organized as mutual associations, 
in which case all the profits from investments are distrib- 



OTHER FINANCIAL INSTITUTIONS 381 

uted among the depositors as interest. They may be or- 
ganized as joint stock associations; in such case the excess 
of earnings above stipulated interest to depositors is dis- 
tributed among the stockholders as dividends. The mu- 
tual form of organization prevails in the northeastern 
states; in the western states provision for savings is usu- 
ally made through savings departments in the ordinary 
commercial banks. In many foreign countries the place 
of the mutual savings bank is taken by municipal and 
postal savings banks and in the United States since 
1 9 10 the post office has conducted a savings bank with 
branches distributed rather irregularly over the country. 
In general, it is recognized that the proper function of 
the savings bank is to promote thrift among the poorer 
classes, not to afford an opportunity for profit to the well- 
to-do. Hence the small depositor is frequently given the 
preference over the large depositor, receiving a higher 
rate of interest. In many cases the size of the individual 
deposit is narrowly limited. In the postal savings system of 
the United States the maximum individual deposit is $1000. 

17. The building and loan association is a form of 
investment company which limits its field to 
small loans on real estate security. 

A financial institution which in some parts of the coun- 
try takes the place of the savings bank in promoting 
saving among the working classes is the building and loan 
association. Each member of the association purchases a 
certain number of shares of ''stock," paying for them in 
monthly installments. If at any time he wishes to with- 
draw, the association returns to him the sums which he 
has paid in, with or without interest, according to the 
time that has elapsed since his first payment. If a mem- 
ber desires to build a house, he may borrow from the 
association a sum not exceeding the par value of the stock 
in the association which he holds. As security for the 



382 INTRODUCTION TO ECONOMICS 

loan, he gives a mortgage upon the house which he builds 
with the aid of the loan. He further binds himself to 
make monthly payments to the association which repre- 
sent interest on the loan, plus some part of the principal. 
Without entering upon the details of the organization of 
such an association, we can see that its object is to col- 
lect sums of capital from persons of small means, with the 
purpose of loaning them to other persons of small means 
who desire to own homes. The latter class pay the in- 
terest that the former class receive. 

18. The Land Bank is an investment company de- 
signed to facilitate the flow of capital into 
agriculture. 
Agriculture, especially when it is conducted under the 
system of relatively small holdings operated by the owner, 
presents peculiar problems of financing. When a farm 
changes hands the buyer is usually not in a position to 
pay down the whole purchase price, but buys under mort- 
gage. Accordingly the load of indebtedness of the typi- 
cal agricultural community is heavy. Until recently in 
America the mortgage loan ran for periods ranging from 
two to five years. Such periods were insufficient to per- 
mit the accumulation of earnings sufficient to pay off the 
principal of the debt. In most cases the loan might be 
extended at maturity, but the debtor always ran the 
risk that payment would be insisted on, and that unless 
another creditor could be found, he might be deprived 
of his holdings through foreclosure proceedings. Rates 
of interest were often unfavorable, since farm mortgages 
were largely restricted to the local market; frequently 
the burden upon the debtor was increased through com- 
missions upon the negotiation or renewal of the loan. In 
contrast, farmers in most European countries enjoyed low 
interest rates and long term loans, through the operation 
of various forms of land banks. 



OTHER FINANCIAL INSTITUTIONS 383 

In 191 6 Congress enacted a law providing for the or- 
ganization of federal land banks, national farm loan 
associations and joint stock land banks. The land bank 
is a corporation with capital subscribed partly by in- 
dividuals, partly by the federal government. Provision 
is made for one such bank for each of twelve divisions of 
the country. The minimum capital is $750,000. The farm 
loan associations consist of groups of ten or more bor- 
rowers, each of whom assumes a liabiHty for all debts 
of the association equivalent roughly to the amount of 
his borrowings. When a loan is desired, the loan com- 
mittee of the association appraises the security and 
recommends it to the federal land bank, which again 
appraises the security. The association indorses the 
mortgage which it receives from the borrower and con- 
veys it to the federal land bank, which then advances the 
funds sought to the association, which in turn advances 
them to the borrower. The federal land bank then issues 
its own debentures in an equal sum and sells them in the 
investment market. This is the economic kernel of the 
whole transaction. The land bank exchanges its credit, 
known universally to be good, for the mortgage secured 
credit of the borrower, known only locally. Even with 
the added expense of conducting so complicated a system, 
the borrower secures his capital at a much lower rate 
than formerly. 

Besides, the loans made under the system run for longer 
periods, from five years to forty, with the influence of 
the banks exerted in favor of fixing the term at thirty- 
five years. Every year the borrower pays, along with in- 
terest on the loan, a fixed percentage which goes to the 
repayment of the principle. Say that he pays five per 
cent interest: he is required to pay one per cent in addi- 
tion, which will amortize or extinguish the principal in 
thirty-five years. Thus he is never put to any serious 



384 INTRODUCTION TO ECONOMICS 

strain in meeting payments due. After five years he may, 
if he chooses, extinguish any part of the loan for which 
he has funds available. 

19. From the financial point of view, the life in- 
surance company is a modified form of 
investment company. The returns from in- 
vestments are for the most part made over to 
the policy holders. 
One further institution requires notice here: the life in- 
surance company. From a financial point of view, the 
life insurance company is a device for accumulating sav- 
ings which shall be returned, either to the man who saves 
in the form of an endowment, or to his heirs at his demise. 
Some of the insured, it is true, die long before the sum 
of the premiums they have paid equals the sum that the 
insurance company has agreed to pay at their death. On 
the average, however, the insured Uve long enough so 
that their premiums, together with the earnings of the 
capital which those premiums form, are at least equal to 
the sums which the insurance company pays out in death 
claims. 

It is obvious that in a country Hke the United States, 
where life insurance is exceedingly common, immense 
sums of money must be collected by the companies every 
year, to be held as a reserve against death claims. As the 
business of Hfe insurance is steadily growing, the funds 
accumulated by these companies are also increasing. The 
annual receipts of all the important life insurance companies 
exceed the annual disbursements. Accordingly, a life in- 
surance company may invest its funds without much 
regard to the possibihty of turning its investments into 
cash at short notice. It is important, however, that the 
business should be conducted in a conservative manner, 
since the failure of an insurance company would be a 
more widely felt calamity than the failure of almost any 



OTHER FINANCIAL INSTITUTIONS 385 

other business enterprise of equal magnitude. The loss 
would be borne in the end largely by the dependents of 
property less men. 

The reserves of life insurance companies are invested 
chiefly in real estate mortgages, in state and municipal 
bonds, and in the bonds of railway, commercial and in- 
dustrial corporations. Stock investments have often been 
made by insurance companies, but the practice is now 
generally regarded with disfavor, since the values of stocks 
are likely to show a wide range of fluctuation. 
20. The mechanism for bringing investor and en- 
terpriser together necessarily becomes more 
complex as industrial operations increase in 
magnitude. 
In a small village, the investor and the enterpriser 
enter into direct relations with each other. In a larger 
town, funds flow from the investor to the enterpriser 
through the intermediation of a broker. In a great city 
funds flow from the investor to the enterpriser through 
the intermediation of a series of brokers and a series of 
speculators; often other functionaries, such as the under- 
writer and the investment company, insert themselves in 
the chain connecting the two primary financial classes — 
the investor and the enterpriser. We shall understand 
this flow of funds better if we construct a diagram repre- 
senting it : — 

Stockholder Depositor Policy Holder 

4' 4' 4" 

Independent Investor Investment Co. Savings Bank Insurance Co. 

i 

(Broker) 

4- 
Speculator 

1 

(Broker) 

..i 

Underwriting Syndicate 

i 

Industrial Enterprise 



386 INTRODUCTION TO ECONOMICS 

In our diagram the broker is placed in parenthesis, be- J 
cause he is nominally an agent for the investor or the 
speculator. The diagram is less complex than the reality, 
because it assumes that only one speculator figures in the 
chain, when in fact a security may pass from one specu- 
lator to another for years before its value becomes suffi- 
ciently stable to attract the interest of investors. 

21. Summary. 

In modern economic society there is a constant flow of 
funds from the capitalist class to the enterpriser class. 
The purchase or improvement of real estate, the financ- 
ing of large business enterprises, and the extraordinary 
needs of governments give rise to the demand for long 
term investment; men retiring from active business life, 
endowed institutions, and persons accumulating capital 
against future needs furnish the supply of such funds. 
This flow of capital may be represented as the purchase 
and sale of stocks, bonds, and mortgage notes. 

Long term investments vary widely in security and 
transferability. As a rule, the greater the degree of secur- 
ity and transferabiHty, the less the productiveness of an 
investment. 

The placing of capital may be effected through direct 
arrangements between the capitalist and the enterpriser, 
or through the intermediation of a broker or other mid- 
dleman. The broker may carry on his business indepen- 
dently, or he may join with other brokers in organizing 
a stock exchange. The purchasers of stocks and bonds 
may hold them for the income which they yield, or for a 
rise in price. In the former case the purchasers are 
classed as investors, in the latter, as speculators. When 
an enterprise is new its securities are chiefly held by spec- 
ulators; when its business is well established, the securi- 
ties are likely to pass into the hands of permanent 
investors. Thus the speculator appears in the light of an 



OTHER FINANCIAL INSTITUTIONS 387 

intermediary between the enterpriser and the ultimate 
investor. • 

Investment may be made through various institutions, 
instead of directly by the capitalist. The most important 
of these are the investment company, the savings bank, 
the building and loan association, and the life insurance 
company. These institutions are adapted to the peculiar 
needs of different classes of investors. They share in 
common the advantages of expert skill in the making of 
investments and of power to distribute investments in 
such a way as to minimize risk. 



CHAPTER XIX 

INTERNATIONAL TRADE AND FOREIGN 
EXCHANGE 

1. All permanent trade rests upon differences in 
productive powers. 

From early modern times, when men first began to 
think systematically upon economic subjects, a great deal 
of attention has been bestowed upon the exchange of 
goods between persons living under different governments, 
or international trade. It was for a long time believed 
(and it is still widely believed) that such trade differs 
radically in its nature from trade that is carried on within 
the hmits of a single country. While the latter, it is 
generally admitted, is an unmixed good, and ought to 
be encouraged, or at any rate granted the most perfect 
freedom by government, the former, many believe, is 
often a doubtful blessing and ought to be closely scru- 
tinized and regulated, and, under many circumstances, 
discouraged or even prohibited. Whether there is any 
justice in this distinction between the two branches of 
trade is a question that we must defer to the next chap- 
ter. For the present, we are concerned with the condi- 
tions giving rise to international trade and the mechan- 
ism by which it is carried on. 

All permanent trade is based upon differences in char- 
acter of productive powers. To employ a simple exam- 
ple, drawn from the field of local trade, if A can make 
three pairs of shoes in a day while B can make only 
two, and B can cut two cords of wood in a day while A 
can cut only one, the basis for permanent trade between 
them exists. It will pay A to get all his wood from B, 

388 



INTERNATIONAL TRADE AND EXCHANGE 389 

exchanging shoes for it. The assumed difference in char- 
acter of productive powers may have originated in differ- 
ences in natural aptitudes or in differences in training. 
In either case the difference in productive powers is the 
essential basis of a continuous interchange of commodities. 

But suppose that A can not only make more shoes in 
a day than B can make, but can also cut more wood. 
Does this supposition preclude the possibility of a per- 
manent interchange of products between A and B? Not 
at all. Suppose that A can make three pairs of shoes in 
a day or cut two cords of wood, while B can make only 
one pair of shoes, or cut only one cord of wood. With 
two days' work B can produce as much wood as A can 
with one; with two days' work he cannot produce as 
many shoes as A can with one. Accordingly, it would 
pay him to offer A the product of a little more than two 
days of his own work at woodcutting, in exchange for 
the product of one day of A's work at making shoes. 
And it would pay A to accept the offer. B suffers under 
a disadvantage in either occupation, but his disadvan- 
tage is less in woodcutting than in shoemaking. A enjoys 
an advantage in either occupation, but his advantage is 
greater in shoemaking than in woodcutting. Common 
sense, then, urges B to confine himself to cutting wood, 
A to making shoes. 

What A would say, in explaining the reason why he 
procured his wood from B, is that his ''time was too 
valuable" to spend on wood cutting. It is too valuable, 
in fact, solely because it can be put to better uses. We 
need not go back to primitive conditions to see this 
principle in action. Why does an able-bodied lawyer 
hire a more or less decrepit workman to mow his lawn? 
Because the lawyer's time is too valuable to be put to 
such uses as mowing lawns. In a very large proportion 
of cases, we hire work done, or buy the products ready 



390 INTRODUCTION TO ECONOMICS 

made, not because we could not do the work ourselves 
in average time or less, but because we have more prof- 
itable uses for our time. 

In the trade between inhabitants of one part of the 
earth's surface with those of another part, differences in 
personal aptitude and training of the kind assumed in the 
foregoing example are supplemented by differences of a 
more general nature. One region may have excellent 
mineral deposits but lack fertile land for the growing of 
food; another region may be quite devoid of minerals, 
but abundantly supplied with rich lands. Capital may 
be plentiful and cheap in one region and scarce and dear 
in another. In this case industries requiring vast capital 
can be operated to greater advantage in the former re- 
gion than in the latter. Land may be plentiful in one 
region, relatively to the population, and scarce in an- 
other. Industries requiring an extensive use of land will 
find their natural habitat in the former region. The 
populations of two regions, though differing little in 
fundamental character, may differ widely in their atti- 
tude toward particular forms of toil. They possess differ- 
ent habits, or, more properly, traditions of workmanship, 
which fit the one better for one kind of labor, the other 
for another. So long as any of these differences persists, 
there is obviously reason why there should be differences 
in the industries of the two regions. With adequate 
means of communication, trade between the two regions 
naturally arises. 

2. Economically considered^ trade should he clas- 
sified as local and interregional, not as 
domestic and international. The latter 
classification may, however, he regarded 
as practically equivalent to the former. 
We have spoken of differences between regions, not 
differences between nations. From a purely economic 



INTERNATIONAL TRADE AND EXCHANGE 391 

point of view, trade is either local or interregional, not 
domestic or international. The trade between Belgium 
and the adjacent departements of France is economically 
of the same character as the trade between Rhode Island 
and Massachusetts. The trade between Cahfornia and 
Hawaii is of the same essential character as the trade 
between New York and Santo Domingo. From an eco- 
nomic point of view local trade is that which originates 
in such differences in natural aptitudes and industrial 
training as may for a long time persist on the same soil. 
Differences in natural endowment, in general character 
of population, in rates of wages and interest, character- 
ize interregional trade. As a rule, however, international 
trade is also interregional; hence the principles that apply 
to the latter may without serious qualifiGation be applied 
to the former. Since the classification of trade as do- 
mestic and international is widely used, we shall accept it 
in the following pages. 

3. Trade between two regions or nations may be 
based upon the fact that each one produces 
goods of a kind that cannot be produced 
within the boundaries of the other. 
In some cases the products of two regions are quite 
dissimilar. Neither region can produce the commodities 
which it receives from the other. Thus in the Middle 
Ages an important trade was carried on between North- 
ern Europe and the Indies. The former region furnished 
furs and amber, the latter, spices and gems. A modern 
example of the same sort of trade is the exchange of iron 
and steel products for teas, coffee, and spices between 
England and the East Indies. In general, the trade be- 
tween countries in the temperate zone, on the one hand, 
and countries in the torrid zone, on the other, is largely 
of this character. Trade having this basis is naturally 
permanent ; with every reduction in costs of transporta- 



392 INTRODUCTION TO ECONOMICS 

tion it tends to increase. Decline in railway and ocean 
shipping charges places more and cheaper tropical prod- 
ucts in our hands, and places more of our products in 
the hands of the inhabitants of the tropics. Further- 
more, we are, as a people, gradually learning to appre- 
ciate the good qualitites in tropical products that a short 
time ago we held in slight esteem; and we may assume 
that a corresponding evolution is taking place in the 
tastes of the inhabitants of the tropics. 
4. Each one of two trading nations may he able 
to produce all classes of commodities that are 
the objects of exchange between them. In 
this case, the one is likely to enjoy greater 
relative advantages for the production of one 
class of commodities, the other for the pro- 
duction of another class. 
More commonly one of the trading regions, or both, 
can produce both classes of commodities exchanged. The 
United States can produce both sugar and pork; so also 
can Cuba. But the United States possesses exceptional 
advantages for the production of pork; for the produc- 
tion of sugar it is not especially well adapted. Cuba, on 
the other hand, has unsurpassed advantages for the pro- 
duction of sugar, but can produce pork with only a mod- 
erate degree of success. It is, therefore, natural that an 
exchange of products between the two countries should 
take place. Were there no artificial hindrances to such 
exchange, we should adjust our production in such a way 
as to produce all the pork that Cuba needs, and Cuba 
would devote more of her productive resources to the 
growing of sugar for our consumption. 



INTERNATIONAL TRADE AND EXCHANGE 393 

5. Trade based upon differences in productive 
power arising from differences in the charac- 
ter of two populations is permanent in charac- 
ter and tends to increase with improvements 
in transportation. 
Among the conditions upon which international trade 
is based, we mentioned differences in the essential char- 
acter of the populations of trading regions. Such differ- 
ences in character are difficult to define, since the charac- 
ters of nations, as of individuals, are always thickly over- 
laid with custom and habit. Nevertheless, we may be 
quite sure that such differences exist. The Frenchman 
is not exactly the same kind of man as the Englishman, 
even if due allowance is made for acquired traits. Still 
less is the Japanese the same kind of man as the Ameri- 
can. It is therefore safe to assume that in some of the 
manifold branches of industry the Frenchman will be supe- 
rior to the Englishman, while in some he will be inferior. 
We may certainly assume that in some branches of indus- 
try the Japanese will be more successful than the 
American, while in other branches he will be less suc- 
cessful. 

Cotton can be grown successfully by the native popula- 
tion of Central Africa. The tedious labor under a tropic 
sun is more easily borne by the native blacks than it 
would be by persons of European descent. The manu- 
facture of cotton cloth by modern methods requires a 
higher degree of intelligence, perseverance, and respon- 
sibility than the native African population possesses. 
This branch of the industry may better be carried on in 
a country like England, where the population has the 
required traits in a high degree of development. Accord- 
ingly, there is a natural basis for permanent trade be- 
tween England and Central Africa. Trade based upon 
such essential differences in national character also tends 



394 INTRODUCTION TO ECONOMICS 

to increase in importance with improvements in the means 
of transportation and communication. 

6. International trade based upon differences in 
relative supply of land eventually loses a large 
part of its importance on account of the move- 
ments of population. 

Trade based upon differences in relative supply of 
land attained extraordinary proportions during the nine- 
teenth century. The Old World, for the most part, was 
densely peopled; in the New World population was 
sparse. It is a well-known fact that the largest output 
per workman of agricultural products is attained through 
the superficial cultivation of large areas. England may 
have lands that are naturally better adapted for the grow- 
ing of wheat than the lands of Argentina. But it is 
hardly possible for one man cultivating twenty acres in 
England to produce as many bushels of wheat as one man 
cultivating two hundred acres in Argentina. 

In manufactures, on the other hand, density of popula- 
tion, instead of reducing productive efficiency, tends to in- 
crease it. Men who live in constant association are better 
fitted for the organized activity of the modern factory 
than are men who pass their lives in the isolation of the 
frontier. Hence an exchange of agricultural products for 
manufactures between the New World and the Old was 
in the natural order of events. 

During the greater part of the nineteenth century trade 
between the United States and England was chiefly of the 
character just described. The United States possessed 
vast tracts of land for extensive cultivation; England had 
a dense population well fitted for factory labor. Hence 
we exported foodstuffs and raw materials and imported 
manufactures. 

While trade upon this basis tends to increase with re- 
duction in costs of transportation, there is a counter tend- 



INTERNATIONAL TRADE AND EXCHANGE 395 

ency at work which in time checks it. Immigration flows 
into the regions rich in land; the natural increase of 
population in those regions is likely to be rapid. In the 
end such regions lose their peculiar advantages in the 
production of foodstuffs and raw materials, and gain in 
power to produce manufactures cheaply. Trade of the 
character under discussion may continue for centuries, but 
ultimately it decays. At the outbreak of the Great War 
the United States, while still an exporter of foodstuffs, 
was moving rapidly toward a condition in which the 
national consumption of food absorbed the whole pro- 
duction. The war, with its huge waste of foodstuffs and 
its disorganization of agricultural production in Russia 
and the Balkans, gave a new stimulus to American 
agricultural exports. As the economic state of the world 
returns to normal, we may expect American exports to 
assume prevailingly the form of manufactured products. 
There is no reason for forecasting a time when the United 
States will be absolutely dependent on foreign supplies 
of food, but incidental imports of food will more than 
balance exports of food before another quarter of a cen- 
tury has elapsed. 
7. International trade based upon differences in 
relative' supply of capital can not long per- 
sist if capital flows easily from country to 
country. 
So long as England was par excellence the land of 
capital, and so long as English capitalists were unwilling 
to invest their funds in foreign lands, there were many 
branches of manufacture that could be prosecuted to 
greater advantage in England than in other countries. 
In practically every branch of manufacture, in fact, the 
interest on capital makes up a far larger proportion of the 
total expenses than in grazing, agriculture, lumbering, etc. 
It is easy to see, then, that English manufacturers, with 



396 INTRODUCTION TO ECONOMICS 

interest at five per cent, enjoyed a decided advantage over 
American manufacturers, with interest at eight per cent. 
The Engh'sh farmers and stockmen, it is true, also had an 
advantage in interest rates over their American competi- 
tors. But the advantage was of less relative importance 
and more easily offset by other factors in which the Amer- 
icans enjoyed an advantage, such as cheaper land. 

Under orderly international conditions no country 
can long hold a branch of trade merely through cheapness 
of capital. Like labor, capital tends to migrate to the 
less developed regions of the world; its migration in- 
volves far less personal sacrifice and far less cost. 
Furthermore, capital increases rapidly in the newer lands. 
If interest rates were much higher in the United States 
than in Great Britain, British capital would steadily flow 
into the former country; and this influx of capital, added 
to the new capital constantly accumulating here, would 
tend to depress interest rates, until there remained no 
perceptible difference in the rates prevaihng in the two 
countries. 

There have always been countries, however, in which 
capital failed to find adequate security. Before the Great 
War the Balkan states, and some of the Latin American 
republics were generally regarded as especially perilous 
fields of investment. At any time war or revolution 
might destroy factories and machinery and other con- 
crete forms of capital. Since the war practically the 
whole of Central and Eastern Europe has come to be 
regarded as a field in which the investor incurs great 
risks. 

In such conditions of excessive risk, local accumulation 
of capital will not be active, nor will capital flow in from 
foreign countries. Production will therefore be confined 
chiefly to the industries requiring a modest investment, 
such as grazing and agriculture. Manufactures, at least 



INTERNATIONAL TRADE AND EXCHANGE 397 

in their more elaborate forms, will have to be imported. 
The exchange based upon such differences in security for 
capital may be relatively permanant. 

8. International trade based upon differences in 

traditions of workmanship often manifests a 
high degree of permanence. 

In a region that has long been devoted chiefly to a 
given branch of industry, something that we may call a 
tradition of workmanship evolves. The best type of iron 
worker is not developed in a single generation. The mill 
that is manned with workers whose fathers and whose 
fathers' fathers were reared in a world of iron manipula- 
tion possesses a decided, though indefinable, advantage 
over the mill that is manned with workers whose ante- 
cedents are of the field or forest. Costly experiments 
in settling urban stock upon farms have lent color to the 
popular view that it takes generations to make a farmer. 
Still more important is the tradition of workmanship in 
industries requiring a high degree of taste and skill. 
Where is the Occidental who can produce a true Oriental 
rug? 

When other conditions are ripe, the population of any 
region may develop the tradition of workmanship neces- 
sary for the successful prosecution of any specific branch 
of industry. But no region can be expected to gain a su- 
periority in all lines. We may at some future time be 
able to make gowns as well as the French, and ivory toys 
as well as the Japanese. But there will always be objects 
of taste which we must buy from the French and the 
Japanese. Trade based upon such differences may, there- 
fore, be treated as permanent in character. 

9. Fluctuations in the value of money may give 

rise to trade of a transitory character. 
In the nineteenth century trade between gold standard 
and silver standard countries was often stimulated or de- 



398 INTRODUCTION TO ECONOMICS 

pressed by changes in the relative values of the monetary 
media. The Oriental or Latin American producer of ex- 
port goods found himself in a position to earn excep- 
tional profits when silver declined. His products were 
valued abroad in gold, but his costs were measured in 
silver. In such a situation, the producer would in the 
long run have to raise wages to counteract the effect of 
the declining value of silver. But wages and other 
factors in cost readjust themselves slowly. In the inter- 
val there are great profits for exporters, and naturally 
an increased volume of trade. 

Still more striking have been the effects of depreciating 
paper currencies since the Great War. Down to 1922 the 
currencies of almost every state of Central and Eastern 
Europe steadily sank in value, until the German mark, 
once worth a quarter of a dollar, came to be worth half 
a cent, and the Russian ruble, once worth half a dollar, 
came to be worth one-thousandth of a cent. Wages, 
though steadily rising, could not keep pace with the 
rising prices of commodities. The producer for export 
therefore enjoyed a special advantage. He paid his 
wages, interest on loans and rent on buildings in the 
depreciated domestic currency and got for his exports 
some international medium that had not been affected 
by depreciation. That left in his hands a margin of net 
profits that was often very considerable. 

It is to be observed that the process of depreciation 
must be continuous if it is to exert a continuous effect 
on exports. If the German mark, after falling to half 
a cent, remained steadily at that point, wages and other 
factors of cost would gradually readjust themselves, until 
the German exporter found himself in the same relative 
position as before the decHne in the mark. 

We have only to reverse the foregoing argument to 
make clear the effect of a rise in the value of currency. 



INTERNATIONAL TRADE AND EXCHANGE 399 

Suppose the German mark rises to one cent, two cents, 
then three. How would that affect the exporter? Wages 
and other factors in cost would not adjust themselves im- 
mediately. The German producer would incur the same 
cost in marks as before, while such international cur- 
rency as he received for his product would buy fewer 
marks. Thus his margin of profit would be cut down, 
or even wholly eliminated. 

10. The foreign trade of modern nations is based 
upon a combination of differences, some of 
a permanent and some of a transitory 
nature. 
In the foreign trade of a great country like the United 
States or Great Britain it is natural that we should find 
one part having one underlying basis, another part 
another basis. In many cases the exportation or importa- 
tion of a commodity arises from a combination of several 
of the causes which we have described as bases of trade. 
The exportation of iron and steel products from Great 
Britain to India is based upon the fact that Great Britain 
has vastly superior deposits of iron ore and coal, cheaper 
capital, and a population better fitted than that of India 
for metallurgical industry and possessing a superior tradi- 
tion of workmanship. The exportation of wheat from the 
United States to England is based upon the greater abun- 
dance of land, and the extensive use of agricultural 
machinery. The importation into the United States of 
French articles of taste may be due in part to superiority 
of the French national character, in this respect; but it 
is undoubtedly due in large part to a superior tradition 
of workmanship on the part of the French. With the 
lapse of time we shall cease to export many of the com- 
modities we now export; many of the commodities which 
we now import will be produced in this country. 



400 INTRODUCTION TO ECONOMICS 

11. A country may import commodities for the 
production of which it is better fitted by 
nature than are the countries which ex- 
port these commodities. Such a proceed- 
ing is economical when the first country 
enjoys even greater advantages in the pro- 
duction of other commodities than the other 
countries enjoy. 
We have, hitherto, considered only cases in which each 
one of two trading regions possesses unique, or at any 
rate superior, advantages in the production of the com- 
modities which it exports. Under certain conditions trade 
may be advantageous even when this is not the case. 
To use a time-honored illustration, let us suppose that 
the United States, by reason of its natural wealth and 
the character of its population, is in a better position to 
produce both wheat and steel than England. A day's 
labor will produce more of either commodity in America 
than in England. Yet it may be profitable for the United 
States to buy its steel from England, giving wheat in 
exchange. We will assume that in America a day's labor 
will produce four bushels of wheat or two hundredweights 
of steel, while in England a day's labor will produce one 
bushel of wheat or one hundredweight of steel. Disre- 
garding the costs of transportation, it would be profitable 
for America to offer England three bushels of wheat in 
exchange for two hundredweights of steel, and it would 
be profitable for England to accept the offer. America 
would thus obtain two hundredweights of steel for three 
fourths of a day spent in wheat growing, instead of spend- 
ing a whole day's labor in making the steel. England 
would obtain three bushels of wheat through two days' 
labor spent in steel making, instead of spending three 
days' labor producing the same amount of wheat. Amer- 
ica possesses an advantage in either industry, but her 



INTERNATIONAL TRADE AND EXCHANGE 401 

advantage is greater in wheat growing. England is at a 
disadvantage in either branch of production, but her dis- 
advantage is less in steel making. It is therefore nat- 
ural, under the assumed conditions, that America should 
make a specialty of wheat production, England of steel 
making, and that the two countries should carry on a 
mutually profitable trade. 

This case is obviously analogous to the case of ex- 
change between shoemaker and woodcutter which we em- 
ployed in the early part of this chapter. But while any 
person of ordinary intelligence can see how it may be 
profitable for an efficient shoemaker to hire a man less 
fitted than himself for woodcutting to supply him with 
wood, it appears to be beyond the comprehension of 
most ordinary men, and many extraordinary ones, that 
a country can profitably pursue the same business policy. 
Since a day's labor does actually produce more steel in 
the United States than in England, many men believe 
that it must be unprofitable for us to buy steel from 
England. Obviously, they fail to consider the possibility 
that we may have other industries so much more pro- 
ductive than those of England that we cannot afford to 
divert our labor to the making of steel. 

12. From the fact that a country has greater 
natural advantages for the production of a 
commodity than other countries enjoy, it does 
not necessarily follow that the money cost 
of the commodity is lower i?i the former 
country than in the others. 
Let lis look at the matter from another point of view 
— that of prices and money cost of production. The 
men who engage in the business of importing and ex- 
porting commodities do not inquire into underlying bases 
of trade. Their inquiries begin and end with prices. Is 
steel cheaper in England than in America? If so, and 



402 INTRODUCTION TO ECONOMICS 

if the difference is great enough to pay the cost of trans- 
portation, they import the steel, unless they are pre- 
vented by government from doing so. Is wheat cheaper 
in America than in England? If it is enough cheaper to 
pay the costs of transportation, they export it. 

But why should steel be cheaper in England than in 
America, while wheat is cheaper in the latter country? 
Prices, we know, tend to equal money cost of produc- 
tion; therefore we may assume that it costs less to pro- 
duce steel in England, wheat in America. Our inquiries 
cannot stop here, however, for we must know why it 
costs more to produce the one commodity in the one 
country, the other commodity in the other country. 

Ask a steel manufacturer why it costs more to produce 
steel in this country than in England, and he will prob- 
ably reply, ''Labor is dearer." The pay of English steel 
workers is, indeed, lower than that of steel workers in 
America, but so also is the pay of English agricultural 
laborers lower than that of farm hands in America. It 
is, therefore, plain that it is not the low wages, absolutely 
considered, that give the British steel manufacturer an 
advantage, but the low wages, relatively to the produc- 
tive efficiency of the workmen. Low wages do not make 
British agriculture prosperous, because the productive 
efficiency of laborers in that industry is low, relatively to 
wages. The disadvantage of the British steel industry as 
compared with the American is less than the disadvan- 
tage of British agriculture as compared with American. 

13. It is profitable to import a commodity when- 
ever labor and capital engaged in its pro- 
duction yield less than the same agents 
would yield in other fields. 

We shall get a clearer view of the situation if we recall 
the principles determining cost of production. Wages and 
interest are the chief constituents of cost of production; 



INTERNATIONAL TRADE AND EXCHANGE 403 

but we will fix our attention upon wages alone. In earlier 
chapters we saw that wages are determined by the 
marginal productivity of labor. Now, let us suppose 
that one trading region has a vast extent of fertile land 
and a sparse population. Only the best lands are tilled 
and these in a superficial way. Add a thousand laborers 
to the population. How much can they produce? Per- 
haps five bushels per man a day. This amount of wheat, 
or the price of it, they can demand as wages; all other 
equally efficient workmen will get as much, but no more. 
Another trading region has, let us say, a dense population 
and little land. All the good lands are carefully tilled; 
most of the poor lands also are under cultivation. Add 
a thousand men to the working population. It is highly 
improbable that these men will increase the product by 
five bushels per man per day. Rather, we may assume 
that the daily product of a man is only one bushel. 
And this, or its price, is all that any equally efficient 
laborer in the society can get. 

If the two regions are in easy communication with each 
other, the price of wheat in the one will be the same as 
the price in the other, allowance made for the cost of 
shipping wheat from the one to the other — a few cents 
per bushel, we will assume. This means that money 
wages will be much higher in the region which is sparsely 
settled than in the region where population is dense. 

Now, let us suppose that each region possesses ores and 
coal, but that the deposits of the sparsely settled region 
are so much the richer that a day's labor will produce 
from them twice as much steel as a day's labor will pro- 
duce from the deposits of the densely settled region. 
Enterprisers of the former region will have to pay miners, 
furnacemen, etc., at least as much as they could earn in 
agriculture — the price of five bushels a day. Enter- 
prisers in the region of dense population will also pay 



404 INTRODUCTION TO FXONOMICS 

wages gauged by the returns to agricultural labor — the 
price of one bushel a day. A simple calculation will show 
that steel manufacturers in the region of dense population 
can produce steel much more cheaply than their com- 
petitors in the other region. 

In order to make our example correspond more closely 
with reality, we should need to substitute, for steel mak- 
ing only, a wide range of industries, mainly manufactur- 
ing; for wheat raising we should substitute a wide range 
of industries, mainly extractive. We might then say, with 
perfect truth, that in a sparsely settled region the mar- 
ginal productivity, and consequently the wages of labor, are 
likely to be so high that manufactures cannot be carried 
on profitably in competition with a densely settled region, 
where the marginal productivity of labor, and hence 
wages, are low. American manufacturers of iron and steel 
products have for a century been forced to pay higher 
wages than English manufacturers, largely because the 
productivity of labor in agriculture was so much higher 
here than in England. 

It is of course possible that in the end methods will 
be found for increasing the productivity of the high 
priced labor of one country so that the wages element in 
cost will be less than in countries of low wages. Well- 
paid labor is likely to be physically more fit and more 
alert mentally. It is better adapted to systematic or- 
ganization and to the operation of complicated machin- 
ery. As a fact, the American iron and steel industry long 
ago overcame the disadvantages of high labor cost. The 
actual cost of most of the important products of the 
industry is no higher than in other industrial countries. 

14. Trade between dif event countries originally 
took the form of barter. 

In early times, interregional trade, like all other forms 
of trade, was carried on through barter. The Phoenician 



INTERNATIONAL TRADE AND EXCHANGE 405 

merchant carried to each port commodities that he 
thought would be in demand there, and bartered them for 
commodities which he desired. In a later stage money 
was employed, but chiefly for effecting exchanges within 
a single locaHty. The artisan merchants of the medi- 
aeval Hanse towns trading with England carried cloth 
and other wares to London and exchanged them for wool 
and other English products. Doubtless when in England 
the Hanse merchants often first exchanged their wares 
for local money, and exchanged the money in turn for 
goods to carry back to Germany. From the point of 
view of the two trading regions, the trade was an ex- 
change of goods for goods, or barter, in spite of the 
employment of money in England. 

After the Great War, in countries where the currency 
had become badly disorganized, international trading 
transactions returned in some instances to their primi- 
tive character. Any merchant who sent goods to Russia 
or Rumania, Poland or Jugoslavia, naturally sought 
to take in exchange some kind of goods which could be 
sold in the world market. The currency of those coun- 
tries would not serve his purpose, since it fluctuated 
wildly in value and might turn out to be utterly valueless. 
He could not accept lands or houses or other immovable 
goods, because he could not have any assurance that 
some political overturn might not result in confiscation. 
If, then, he sold goods for currency it was with the 
intention of turning the currency immediately into 
goods. 

The character of international trade as barter is only 
slightly obscured where the currencies of both trading 
regions, though fluctuating with respect to each other, 
command a fair degree of confidence. During the Great 
War and the post-war disorders, gold, which had 
been the basis of the currencies of all the important 



.406 INTRODUCTION TO ECONOMICS 

commercial nations, was displaced through almost all 
Europe by paper currencies. The only commercial pow- 
ers of the first rank that maintained the gold standard 
through that period were the United States and Japan. 
In Great Britain, France and Italy, the money in daily 
use was paper, which fluctuated considerably in value. 
Accordingly, any American exporter to one of those 
countries had to take either goods in payment or paper 
that might sink enough in value to wipe out his profit. 
Of course it might also rise enough in value to double 
his profit. To sell his goods for currency thus involved 
a speculative element in addition to the possible fluctu- 
ations in the prices of the goods he exported. And the 
ordinary exporter is not prepared to engage in currency 
speculations. 

In every great commercial center, however, there is 
to be found a body of men whose business is to specu- 
late in fluctuating values, foreign currencies among the 
rest. Say that an American exporter ships a hundred 
thousand pounds of cotton to a customer in France, tak- 
ing in return two hundred thousand paper francs. Within 
the month the franc may sink to seven cents or it may 
rise to nine. Its current value in the speculative market 
is, we will say, 8 J cents, and the merchant has only to 
sell his francs to translate the value into American money. 
The speculator may lose on the transaction, but on the 
other hand he may gain. He is doing business with his 
eyes open. 

But what becomes of the francs in the speculator's 
hands? He certainly does not intend to hold them until 
that remote time when he might send them to France 
and obtain their face value in gold. He holds them 
merely until a customer appears to buy francs at what 
seems to him a good price. Say that an American house 
wishes to import goods from France. Or that an Amer- 



INTERNATIONAL TRADE AND EXCHANGE 407 

ican wishes to buy a house in France, or provide for the 
expenses of a protracted sojourn there. He buys francs; 
perhaps from the identical fund created by the export 
of cotton to France. 

American trade with a country which employs a paper 
currency is, in the large, barter. We exchange American 
goods for French goods of equivalent value. The inter- 
vention of speculators in currency may obscure the re- 
lation slightly. For several months we may export more 
to France than we receive in exchange in the form of 
goods, in the meantime heaping up the supply of francs 
in the hands of the speculators. Or we may sell goods 
in France on credit, in terms of dollars, leaving it to our 
French customers to run the risk of a decline in francs 
which makes dollars ruinously dear when they have to 
make good on their contracts. In either case, if the 
volume of excess claims on France becomes too heavy, 
the American price of francs is likely to decline. This 
makes it easier to pay for imports from France and harder 
to sell exports there advantageously. Thus forces are 
set in operation which tend to restore the equilibrium 
of exports and imports. 

Where both trading countries employ the gold stand- 
ard the relation between imports and exports may drift 
farther away from the equilibrium represented by direct 
barter. An exporter sells his goods for what they will 
fetch, taking the price in gold. He may carry the gold 
back to his country, if he chooses, have it recoined at 
the mint without cost or at nominal cost and use it like 
any other money. Here it looks at first as if no neces- 
sary relation existed between exports and imports. We 
shall examine into the case in detail, because it is typical 
of normal economic conditions. There may be protracted 
periods of disturbance like the present when each nation 
has its own special currency, fluctuating in value accord- 



4o8 INTRODUCTION TO ECONOMICS 

ing to its own laws. But sooner or later the normal 
condition of interchangeable standards will return. 

15. The use of gold in international payments is 
largely obviated by the employment of bills 
of exchange. 

Let us suppose that A, an American exporter, has 
sold 50,000 pounds of cotton to X, a J^anese importer, 
at the price of 20 cents a pound. If he wishes the 
$10,000 delivered to him in America in gold, he must, 
of course, pay freight and insurance on it. This will 
cost about $1 for every $100, or $100 for the entire sum. 

But suppose that after shipping the cotton, and before 
giving orders for the delivery of the gold, he meets B, an 
American importer, who is about to order $10,000 worth 
of silks from Y, a Japanese exporter. If B were to ship 
the $10,000 in gold to Japan, it would cost him $100 for 
freight and insurance. Now, if A will give B an order 
instructing X to pay Y the $10,000, instead of remitting 
it to himself, B can pay A the $10,000 that he would 
otherwise have remitted to Y. Both debts will be ex- 
tinguished by such an arrangement, and both A and B 
can save $100 by it. 

Such an order as we have assumed that A gives to B, 
requesting X to pay Y a certain sum originally due to 
A, is known as a bill of exchange. Such a bill may be 
payable as soon as it is presented to the person upon 
whom it is drawn, or it may be payable after the ex- 
piration of a period of time — twenty, thirty, sixty days. 
In the former case it is a ''sight bill," in the latter, a 
"time bill." Time bills usually bear interest — a fact 
that assimilates them to other credit instruments, but 
has no bearing on the principles of exchange. We shall 
therefore assume that bills of exchange are sight bills only. 

In our example it appeared that both A and B gained 
$100 by the arrangement. Now, if B had been unwilling. 



INTERNATIONAL TRADE AND EXCHANGE 409 

for some reason, to give A $10,000 for the latter's bill of 
exchange, A might have taken less. It would have been 
more profitable for him to take $9910 than to incur the 
expense of importing the gold. If B had offered $9900, 
it would have been a matter of indifference to A whether 
he sold his bill to B or imported the gold. $9900 is evi- 
dently the very lowest price at which the bill would be 
sold. On the other hand, if A had been unwilling to 
part with his bill for just $10,000, B might have offered 
more, for he could better have afforded to pay $10,090 
for the bill than stand the expense of exporting gold. If 
A had demanded $10,100, it would have been a matter of 
indifference to B whether he bought the bill or shipped 
the gold. $10,100 is, then, the very highest price that a 
$10,000 bill can be made to fetch. 

16. Bills of exchange sell at par when the supply 
of them just equals the demand. When 
the supply is less than the demand, they 
rise above par; when the supply exceeds 
the demand, they fall below par. 
When a bill of exchange sells for just its face value, it is 
said to be at par; when for more or less, it is above or 
below par. We have now to inquire under what condi- 
tions bills will be at par, or above or below par. 

If the importer whom we designated as B thinks that 
the chances are good that he can find other exporters be- 
sides A who wish to dispose of bills of exchange, he is 
likely to offer less than par for A's bill. If one of the 
holders of bills will not sell at a low price, another prob- 
ably will. If, on the other hand, A thinks that he can 
easily find other persons besides B who have payments to 
make abroad, and who wish to purchase bills for the pur- 
pose, he is likely to hold his bill at a price above par. In 
general terms, when the volume of bills offered for sale 
appears to exceed the volume of remittances to be made 



4IO INTRODUCTION TO ECONOMICS 

to a foreign center, bills fall below par. When the volume 
of bills appears to be inferior to the volume of remittances 
to be made, bills rise above par. In the former case, each 
holder of a bill knows that some bills cannot be sold at 
all; their holders will have to go to the expense of import- 
ing specie. Rather than be left in this position himself, 
he is willing to sell his bill at less than its par value, pro- 
vided that the price offered is not so low that to bear the 
cost of importing specie would be a lesser evil. In the 
latter case each person having remittances to make knows 
that some men will have to go to the expense of exporting 
specie. Hence each one will offer more than its par value 
for a bill of exchange. 

17. Whether bills are at par or above or below par 
depends on the total volume of payments be- 
tween trading regions. 

We must now endeavor to determine the conditions 
under which the volume of bills equals, is superior to, or 
inferior to, the volume of remittances. We shall assume 
that the relations between the United States and Japan are 
carried on without regard to relations with other countries. 

The United States, we will assume, exports in one year 
products worth $200,000,000 to Japan, and Japan ex- 
ports products worth $350,000,000 to the United States. 
Under the head of exports and imports, we shall have 
bills on Japan aggregating $200,000,000, and remittances 
to make aggregating $350,000,000. 

The Japanese government and its nationals owe con- 
siderable sums to citizens of the United States; citizens 
of the United States owe lesser sums to citizens of Japan. 
Interest on these debts will be transmitted by way of 
exchange. Let us say that Japan must pay us 
$25,000,000, while we must pay Japan $5,000,000. This 
will add $25,000,000 to the total volume of bills, and 
$5,000,000 to the aggregate of remittances. 



INTERNATIONAL TRADE AND EXCHANGE 411 

Some Japanese borrowers are paying off their debts to 
American capitalists; others are borrowing fresh capital. 
The sum of payments we will assume is greatly inferior 
to the sum of new loans. We will put the former at 
$5,000,000, the latter at $25,000,000. Under this head, 
then, we may add $5,000,000 to the volume of bills, 
$25,000,000 to the volume of remittances. 

Americans living or traveling in Japan must have their 
incomes sent them from here; Japanese living or travel- 
ing here must have their incomes sent from Japan. Let 
us suppose that we must send $15,000,000 to our citizens 
in Japan; Japan must send $5,000,000 to her citizens 
here. This would add another $5,000,000 to the volume 
of bills, $15,000,000 to the volume of remittances. 

Most of our trade with Japan is carried on by Japa- 
nese ships. We must, of course, pay for the service, and 
our payments must be sent to Japan. We will place the 
aggregate at $25,000,000. What we carry for Japan may 
be put at $15,000,000. So we must add $25,000,000 to 
the volume of remittances and $15,000,000 to the volume 
of bills. 

DUE THE UNITED STATES DUE JAPAN 

Exports $200,000,000 $350,000,000 

Interest 25,000,000 5,000,000 

Proceeds of new loans, 25,000,000 Repayment of old 

loans 5,000,000 

Japanese travelers' ex- American travelers' 

penses 5,000,000 expenses 15,000,000 

Payment for ocean 

transportation 15,000,000 25,000,000 

$270,000,000 $400,000,000 

Footing up the assumed items of indebtedness, we find 
that the United States can draw bills to the amount of 
$270,000,000, and must make remittances to the amount 
of $400,000,000. Exchange on Japan will be above par 
under these conditions. 



412 INTRODUCTION TO ECONOMICS 

If the United States and Japan formed a closed trad- 
ing circle, having no other relations with other countries, 
exchange would rise to the point where it paid to ship 
gold to Japan, and it would continue at this point until 
enough gold had been shipped to cover the excess of 
debits over credits. 

18. The price of exchange on any country de- 
pends upon the balance of indebtedness be- 
tween that country and all other countries, 
not upon the balance of indebtedness be- 
tween that country and any particular 
country. 

For simplicity we assumed that the exchange relations 
between the United States and Japan were not compli- 
cated by relations with other countries. This assumption 
we must now abandon. Japan buys manufactures from 
England. England buys wheat from the United States. 
Now, it is evident that Japanese exporters to America will 
be glad to accept from American importers bills of ex- 
change drawn on England, as these bills will be in de- 
mand among Japanese importers of British manufactures. 

And so, even though Americans have to remit 
$400,000,000 to Japan, while Japanese have to remit only 
$270,000,000 to America, American exchange may still 
be above par in the Japanese market. Japan may have 
imported from England, France, Germany and Italy an 
excess of imports greater than $130,000,000, her excess 
of exports in the American trade, and exchange on 
America will serve to pay off debts to the European 
countries, which in turn will use the claims acquired from 
Japan to pay for excess imports from America. 



INTERNATIONAL TRADE AND EXCHANGE 413 

19. // other items of international payments re- 

main unchanged, the price of hills of ex- 
change is lowered by an increase in ex- 
ports or a decrease in imports; it is raised 
by a decrease in exports or an increase in 
imports. 
If we assume that other items of international pay- 
ments (transmission of capital, interest payments, travel- 
ers' expenses, payments for ocean transportation) remain 
constant, fluctuations in exchange will always follow 
fluctuations in exports and imports. If we increase our 
exports, imports remaining unchanged, the supply of bills 
increases, and their price tends to fall. If we increase 
our imports, exports remaining the same, the volume of 
remittances to be made increases, and exchange rises in 
price. 

20. Fluctuations in the rate of exchange tend to 

bring about a balance of international pay- 
ments, through stimulating exports and dis- 
couraging imports, when exchange is above 
par, and through discouraging exports and 
stimulating imports when exchange is below 
par. 
When bills are above par, it is more than usually profit- 
able to export goods. Let us suppose that in America 
the price of cotton is twenty cents a pound, while in 
Japan the price is twenty -five cents. If it costs four cents 
a pound to ship cotton from America to Japan, the ex- 
porter will make $1,000 on a 100,000 pound shipment, 
if exchange is at par. If exchange is at its maximum 
above par, the exporter will be able to sell his $25,000 
bill for $25,250, thus adding $250 to his nominal profit 
of $1,000. If exchange is at its minimum below par, the 
exporter can get only $24,750 for his $25,000 bill, thus 
losing $250 of his nominal profit of $1,000. If a profit 



414 INTRODUCTION TO ECONOMICS 

of $i,ooo on 100,000 pounds of cotton is just suffi.cient to 
induce exporters to ship cotton, no cotton will be shipped 
if exchange is below par. 

When exchange is below par, it is more than usually 
profitable to import goods. Let us suppose that it barely 
pays to import a certain kind of Japanese silks when 
exchange is at par; that under these conditions the im- 
porter makes only $100 on a $10,000 shipment. If ex- 
change is at its lowest price, the importer can pay for his 
goods with a $10,000 bill costing only $9900. Thus he 
adds $100 to his profits. If exchange is at its highest 
price, and the importer must pay $10,100 for a $10,000 
bill, the importer's anticipated profit is entirely wiped 
out. 

It follows that there is a tendency for an excess of 
either exports or of imports to check itself. If our ex- 
ports increase, other things equal, exchange falls, and 
this discourages further exports, but encourages imports. 
If our imports increase too rapidly, exchange rises, and 
this discourages further imports and encourages exports. 
The fluctuations of the rate of exchange, then, have a 
tendency to create a balance of exports and imports — 
allowance made for other items of international indebt- 
edness. Exports and imports, in the long run, must 
increase or decline together. 

21. // the difference in the general price level be- 
tween two countries is so great that fluctua- 
tions in the price of bills of exchange can- 
not bring about a balance of payments, 
gold flows from the one country to the other 
until the price level becomes practically the 
same for both. 
But suppose that the margin between prices in two 
countries is so wide that it pays to export in spite of a 
low price for exchange, or to import in spite of a high 



INTERNATIONAL TRADE AND EXCHANGE 415 

price. In the former case, gold must be imported to pay 
for the exports; in the latter, gold must be exported 
to pay for the imports. Now, we saw in an earlier chap- 
ter that an increase in the supply of money tends to raise 
prices; a reduction of the money supply causes prices to 
fall. If, then, our prices are so low that men find it prof- 
itable to send an excess of commodities abroad for sale, 
to be paid for in gold, the condition must be transitory. 
For as the gold flows into the country, prices rise, and 
the exporters' gains grow smaller and smaller. If, on the 
other hand, general prices here are so high that it pays 
importers to bring into the country vast amounts of 
goods, to be paid for by exportation of gold, the condi- 
tion must be equally transitory. With the efflux of gold, 
prices fall, and the profits of importers dwindle away. 
In the end more of our commodities become cheap enough 
to export; and so the balance between exports and im- 
ports is restored. 

There are men who hold that the United States should 
endeavor to increase its exports, but systematically dis- 
courage importation. It is obvious that such a policy 
would be futile. If our exports increase, our imports will 
necessarily increase also, and vice versa. The fluctua- 
tions in the price of foreign exchange, and the effects of 
influx or efflux of gold, insure this result. Exports and 
imports are indissolubly united by natural law; govern- 
ments can destroy both, but no policy can be successful 
which aims to foster the one while persecuting the other. 

22. Summary. 

Trade, both domestic and international, is based upon 
differences in productive powers. The trade between two 
nations may arise from the fact that each possesses exclu- 
sive powers of producing certain commodities; or it may 
arise from the fact that each is superior to the other in 
some particular branch of production. The differences in 



4i6 INTRODUCTION TO ECONOMICS 

productive powers upon which international trade is based 
may be due to differences in the character of population, 
differences in traditions of workmanship, differences in 
natural endowment, or differences in supply of capital. 
Of these differences some tend to disappear with lapse of 
time, while others constantly increase in importance. 

A country may profitably import commodities for the 
production of which it possesses natural advantages supe- 
rior to those of the exporting country. This is often the 
case when the marginal productivity of labor and capital, 
arid hence money cost of production, is higher in the 
former country than in the latter. 

The trade between two countries is carried on through 
the mechanism of exchange. Gold payments are reduced 
to a mere settlement of balances; hence it may be said 
that international trade is essentially barter. 

When exports exceed imports, other things equal, ex- 
change falls below par; and this tends to encourage 
importation and discourage exportation. When imports 
exceed exports, exchange rises above par; and this tends 
to encourage exportation and discourage importation. 
Thus fluctuations in the rate of exchange tend to bring 
about an even balance of exports and imports. If for any 
reason the balance of trade inclines persistently in one 
direction or the other, gold is imported or exported, and 
this, through affecting prices both domestic and foreign, 
ultimately establishes an even balance of international 
exchange. 



CHAPTER XX 
THE REGULATION OF FOREIGN TR/^DE 

1. Foreign trade is subjected to governmental reg- 
ulation chiefly under the form of taxation. 

Since early modern times a great part of the energy 
of governments has been expended upon the regulation of 
international trade. The reason for such regulation has 
been twofold. In the first place, there is a deep-rooted 
beKef in the people of every nation that the national pros- 
perity may be furthered by restrictions upon trade with 
foreigners. In the second place, such trade has long 
been recognized as a convenient and appropriate source 
of public revenue. 

A century ago the policy of prohibiting the importation 
of some classes of goods, and the exportation of other 
classes, was widely followed. By the middle of the nine- 
teenth century this policy had fallen into disuse, except 
in countries in a low stage of economic development, like 
Russia and some of the Balkan states, where the exporta- 
tion of foodstuffs was prohibited in times of scarcity, in 
order to reduce the risks of famine. The Great War pro- 
duced a reversion to an earlier stage of history in many 
parts of the field of trade. Every belligerent state pro- 
hibited the export of various commodities deemed es- 
sential to national security, and most of them prohibited 
the importation of various unessential commodities, as 
involving a strain upon the national credit resources. 
After the war prohibition of imports and exports was 
freely resorted to in central and eastern Europe, as an 

417 



4i8 INTRODUCTION TO ECONOMICS 

instrument for coercing an unfriendly neighbor. Omit- 
ting such abnormal cases, however, we may say that the 
regulation of foreign trade is everywhere carried on under 
the guise of taxation. If we wished to prohibit the im- 
portation of cotton from Egypt, we should place such 
high taxes upon imports of Egyptian cotton that no one 
would find it worth while to import it. 

Taxes on foreign trade may be levied upon either im- 
ports or exports or upon both. Export taxes are generally 
unpopular, because of the common belief that it is a good 
thing to export as many goods as possible. During the 
Great War and for several years after, England levied 
heavy export duties on coal and secured considerable 
revenues from this source. In the United States export 
taxes are prohibited by the Constitution. We shall there- 
fore confine our study to taxes on imports. 

2. Import taxes, or ^^ duties, ^^ maybe levied for 
the sole purpose of raising a revenue, or for 
the purpose of raising the price and thus 
discouraging the importation of commodi- 
ties of classes that can he produced within a 
country. Taxes levied for the former pur- 
pose are called revenue duties; taxes levied 
for the latter purpose are called protective 
duties. 
All the tea used in the United States comes from for- 
eign soil. A tax or ''duty" of, say, five cents a pound 
would raise the price by five cents, but this would check 
importation in only a slight degree. Most of us would 
use as much tea, even at the higher price. A duty of 
$20 a ton on steel, on the other hand, would practically 
prohibit the importation of steel. For our own steel in- 
dustry can produce steel almost, if not quite, as cheaply 
as that of any foreign country. Suppose that we can 
produce steel at $20 a ton while in some foreign country 



THE REGULATION OF FOREIGN TRADE 419 

it can be produced at $17. If the cost of bringing steel 
from the foreign country is $2 a ton, foreign producers 
can sell steel here at lower prices than our own producers 
can afford to take. But if foreign steel is compelled to 
pay a duty of $20 a ton, none of it can be sold here, un- 
less the American producers combine and force steel up 
to the price of $39 a ton. Such a duty, since it "protects'' 
domestic producers against foreign competition, is known 
as a protective duty. 

All duties levied upon imported goods of a character 
that cannot be produced in a country may be classed to- 
gether as pure revenue duties. All duties levied on goods 
of a character that can be produced in a country are pro- 
tective duties. Of course a duty the aim of which is the 
raising of revenue may be incidentally protective. Thus 
if we were to levy a duty on imported coffee, it would 
"protect" the coffee growers of Porto Rico. On the 
other hand, protective duties may incidentally yield a rev- 
enue. In the case employed above, if the duty on foreign 
steel had been $1 instead of $20, foreign steel would have 
continued to be imported, and thus a revenue would have 
been obtained. At the same time the foreigner would 
have been prevented from underselling the American; 
accordingly, the latter would have been ^'protected." 
Most of our duties are protective, but incidentally yield a 
revenue, as they are not high enough to prevent importa- 
tion altogether. 

The schedule of all duties levied by a country is known 
as the ''tariff." A tariff consisting of duties whose main 
object is the raising of a revenue is known as a revenue 
tariff. Such a tariff has long been in force in England. 
It must necessarily be confined to a small number of 
items, since there are very few commodities that cannot 
be produced in a country of varied resources like the 
United States. Tea, spices, natural camphor, rubber^ 



420 INTRODUCTION TO ECONOMICS 

cocoanuts and similar tropical products are commodities 
that would be suitable for revenue duties. A protective 
tariff consists of duties whose main purpose is the protec- 
tion of domestic producers against foreign competition. 
Such a tariff has been in force in the United States since 
early in the nineteenth century; its character has been 
most strongly marked since the Civil War. 

3. Revenue duties on imports are among the most 
convenient and most popular forms of taxation, 
partly because the taxpayer does not realize 
how heavy the taxes are, and partly because 
of the common belief that such taxes are 
borne by the foreigners who export the goods. 
Every government needs large funds for the mainte- 
nance of the numerous corps of ofhcials and servants 
making up its civil and military establishments and for 
the meeting of other expenses incurred in the discharge 
of its various functions. These funds must be obtained 
chiefly through taxation. Two methods of raising taxes 
are open to the government. It may send its officials y 
to each man's house, and levy upon his income or prop- 
erty. In this case it is said to levy direct taxes. The 
government may, on the other hand, impose taxes upon 
salable commodities as they are found in the hands of 
producers or dealers. The latter then add the tax, if 
they can, to the selling price of the commodities taxed. 
If the tax is very light, or if the producer is a monopo- 
list who is already fixing prices at as high a point as the 
consumers will endure, it may be impracticable thus to 
shift the tax to the consumer. But in the case of all 
commodities produced under competitive conditions, the 
tax operates like an addition to costs and it reappears 
in the price. The buyer of the commodities thus bears 
ultimately all or the greater part of the tax. Such taxes 
are said to be indirect. 



THE REGULATION OF FOREIGN TRADE 421 

For such obvious and imperative needs of government 
as the construction of highways, the maintenance of 
courts and schools, the average citizen is wilHng to pay- 
direct taxes, although he usually quarrels with the amount 
imposed upon him. When a war is to be financed, or 
preparations are making for a war that seems imminent, 
direct taxes, however onerous, will be borne without 
murmur. During the Great War income taxes in Amer- 
ica were raised to a point where they absorbed over one- 
half of the income of many individuals, yet there was 
comparatively little outcry. After the war opposition to 
the high rates became more and more vigorous. Any 
new service to be undertaken at the expense of the treas- 
ury was resisted. And that may be said to be the normal 
condition. It is hard to finance through direct taxes 
scientific inquiry, public health inspection and the thou- 
sand and one inconspicuous but valuable creative activ- 
ities of government. For this reason, national govern- 
ments rely in normal times largely upon indirect taxes. 
The average citizen has no very clear idea as to the 
amount of taxes he pays in this way. Whenever you 
buy a pound of imported sugar (and most of our sugar 
is imported) you pay a tax. Whenever you buy English 
woolens or cottons or French silks, you are taxed. If 
you use tobacco in any form, you pay taxes on it. And 
so with a host of other commodities. How great is the 
aggregate yearly sum that you contribute to government 
in indirect taxes? You probably have not the least idea. 
But this is certain; if the entire amount were collected 
from you in cash at one time, you would be much less 
complacent aboi^t government enterprises involving heavy 
expense. 

Of all indirect taxes, those levied on foreign trade are 
the most convenient. All foreign goods must cross the 
national frontier, where there are always officials and 



42 2 INTRODUCTION TO ECONOMICS 

soldiers whose services can be employed in preventing 
goods from being secretly carried into the country. A 
few points through which such goods must pass may be 
designated; a comparatively small body of officials may 
be stationed at these points to levy and collect the taxes. 

Another reason for the popularity of taxes on imports 
is that many persons believe that such taxes are borne by 
foreigners. If we tax British woolens, French silks, and 
German sugar, are we not compelling the British, French, 
and Germans to help pay the expenses of conducting our 
government? 

4. Import duties are, as a rule, borne by the con- 
sumer, not by the importer nor by the pro- 
ducer. 

Let us sa}^ that a given grade of woolen goods is pro- 
duced in England at a cost of fifty cents a yard. Under 
the laws of competitive industry, the cloth sells in Eng- 
land for very nearly fifty cents. If the cost of bringing it 
to this country is one cent a yard, and there is no tax to 
pay on imports, the cloth will sell here for about fifty-one 
cents. Now if we place a duty of fifty cents a yard on the 
cloth, none of it will be sold here for less than the British 
price plus the cost of transportation plus the tax, or a 
dollar and one cent. The man who buys the goods for 
use pays the tax, in the last instance. And so with most 
import duties. Even those who talk most loudly about 
taxing the foreigner make haste to supply themselves with 
such imported goods as they may require in advance of 
any proposed increase in duties. They know by expe- 
rience that the price will rise when the duties go into effect. 

But will the price rise by the whole measure of the 
duty? That will depend on circumstances. After the 
Great War American manufacturers of coal tar dyes 
declared that even a high schedule of duties would not 
protect them against German competition, because the 



THE REGULATION OF FOREIGN TRADE 423 

German exporters would absorb the tax and sell dyes 
here as cheaply as before, rather than permit the devel- 
opment of an American dye industry. No doubt this 
danger was exaggerated. But the point is of some im- 
portance, nevertheless. A business which derives a large 
part of its income from foreign sales, if it possesses mo- 
nopoly powers and can stand the loss, may assume all or 
a part of the duty levied upon its goods by a foreign 
government. 

Again, when an industry is largely dependent upon a 
particular foreign market, a duty making access to that 
market difficult may produce a general reduction in the 
costs of that industry, and so make possible the resupply- 
ing of the foreign market at a price less than the original 
cost plus the duty. The raw silk industry of Japan is 
dependent, we will say, on the American market for a 
great part of the demand that sustains the value qf its 
product. Suppose that we place so heavy a duty on^raw 
silk as greatly to curtail its use in manufacture. The 
Japanese industry would find its products accumulating 
in its hands. There would be a slump in values, which 
would be reflected back in a reduction in the return to 
capital of the industry, and hence in a scaling down of 
capital values. There would also be a reduction in the 
wages of laborers engaged in the industry. Let us say 
that the duty in question amounted to fifty per cent on 
the value of the silk. It is possible that the readjust- 
ments in profits and wages would reduce costs by twenty- 
five per cent. In that case we should find that the fifty 
per cent duty, instead of raising prices by fifty per cent, 
was raising them by only twenty-five per cent. Our con- 
sumers and the Japanese producers would be dividing the 
tax between them. 

We see, then, that there is a theoretical possibihty of 
making the foreigner pay a considerable fraction of cer- 



424 INTRODUCTION TO ECONOMICS 

tain import duties. We should not, however, overrate 
this possibility. There are very few foreign industries 
so dependent on a particular foreign market as in our 
hypothetical case. British industries, for example, look 
to a world-wide market. If we make their access to the 
American market more difficult through increased duties, 
they sell more in other countries and less here, until we 
are willing to pay a price nearly equal to the old price 
plus the duties. Thus we pay practically the whole tax 
ourselves. 

5. Protective duties are sometimes advocated as a 
means of keeping money at home. 

While the raising of a revenue is an important object 
of every tariff, it is not the primary object of American 
tariff policy. That object is protection. A protective 
tariff is designed to foster domestic industry at the ex- 
pens^ of the business of importation. Whether it does 
this or not is a question of great importance. We must 
see exactly how such a tariff affects, not merely isolated 
branches of industry, but the industry of a nation as a 
whole. 

There is a very primitive view, unfortunately yet far 
from extinction, that it is an evil thing to buy anything 
from foreign producers — even the things that cannot be 
produced in the country at all. Those who hold to this 
view imagine that we must send abroad money to pay 
for all purchases, and money, they say, should be kept 
at home. We saw in the last chapter that the medium 
through which international payments are effected is, in 
normal times, bills of exchange. The shipping of gold 
from country to country is reduced, by the mechanism 
of exchange, to very small proportions. Now, the bills 
of exchange with which we pay for our imports are really 
due bills, representing the value of commodities that we 
export. We saw also that if a country for a time imports 



THE REGULATION OF FOREIGN TRADE 425 

more than its exports will pay for, bills on foreign points 
rise in price, and this discourages further importation and 
encourages further exportation, until the proper balance 
between imports and exports is again restored. Accord- 
ingly, we may cheerfully proceed to import as large a 
volume of commodities as we may require. We shall 
not thereby run the risk of a serious drain upon our 
money supply ; we shall merely make preparations for an un- 
usually large and profitable export trade in the near future. 

6. There is no sound reason for discouraging im- 
portation from countries which do not take 
commodities in exchange. 

Some men who have advanced beyond the view that 
all importation of commodities is an evil yet cling to the 
belief that importation from countries that do not buy as 
much from us as we buy from them is to be discouraged. 
They argue that such trade must leave a balance which 
we must pay in gold, and this they regard as a net loss. 
About twenty-five years ago one of the administrative 
departments of our national government published a re- 
port containing the statement that our losses from trade 
with South America, during the preceding half century, 
had exceeded the cost of the Civil War. For we had 
purchased from those countries billions of dollars' worth 
of commodities in excess of their purchases from us. Of 
course, the facts in the case are, not that we sent billions 
of dollars in gold to South America, but that we paid the 
balance in bills on England. England was then buying 
more from us than she sold to us, and in her turn, was 
selhng more to South America than she bought from that 
region. How could it have made any difference to us 
whether the goods with which we paid for South Amer- 
ican products were actually consumed in South America 
or in England? 

We buy more from Japan than we sell to Japan. Japan 



426 INTRODUCTION TO ECONOMICS 

buys more from the rest of the world than she sells. That 
means that in England, Italy, Germany, India and China, 
wherever Japanese purchases are in excess, there is a 
possible market for American goods. This market would 
not exist if we placed an embargo on trade with Japan 
the moment our imports from Japan exceeded our exports 
to that country. 

The principle involved is that by its imports a nation 
helps to create a demand for its exports, and by its 
exports it finds means for financing its imports. This 
principle has been strikingly illustrated by the economic 
depression following the Great War. Because Russia had 
very little to export, she could import little, and the ex- 
port industries of England and Germany suffered severely 
in consequence. Because Germany was unable to find 
satisfactory foreign markets for her industrial products, 
she could not import raw materials and foodstuffs so 
liberally as her natural requirements demanded. Hence 
low prices for American copper, cotton and agricultural 
products. 

Thus we see not only that our own exports are de- 
pendent on our imports but that the prosperity of our 
foreign trade depends on that of all the countries asso- 
ciated in commercial intercourse. Russian exports de- 
cline; accordingly Russian imports decline. Although 
we have never had an important trade with Russia, our 
own trade suffers through the effect of Russian commer- 
cial collapse upon our customers in western Europe. In- 
ternational trade to-day ought to be looked upon as a 
vast coordinated movement, which brings prosperity or 
depression to all the countries that engage in it. Nothing 
could be more stupid than the practice of isolating cer- 
tain elements in the trade of a particular nation and 
judging them good or bad without reference to their 
place in the general movement of international trade. 



THE REGULATION OF FOREIGN TRADE 427 

7. The argument that the national wealth is neces- 
sarily reduced when one purchases from 
abroad commodities that can he made at 
home is fallacious. 
Slightly less shallow is the view that one should not 
buy from foreigners commodities that he can obtain from 
his fellow-citizens, even if the latter demand higher prices 
than foreigners are content to receive. If you wish to buy 
an automobile, it is urged, you should buy one of Amer- 
ican make, even if you can get a better one of French 
make at the same price. By so doing you will increase 
the prosperity of the American automobile industry. You 
will enable the industry to employ more men at higher 
wages, and to pay higher dividends to those who have 
invested their capital in the industry. And if you are not 
sufficiently moved by patriotism to favor the industry 
of your fellow-citizens over that of foreigners, it is right 
that the government should compel you to do so, through 
the imposition of heavy duties. 

The ulterior effects of a policy that compels American 
buyers to patronize the home industry are no less happy 
(so runs the familiar argument). The laborers and cap- 
italists, being more prosperous, have more to spend on 
products for their own use. The capitalists erect man- 
sions and the laborers build cottages, and this creates 
employment for carpenters, masons, and other craftsmen 
in allied trades. These in turn have more money to 
spend, and increase their purchases of clothes, provisions, 
and other articles of use. And so the beneficent effects 
of confining one's purchases of automobiles to the Amer- 
ican industry are widely distributed throughout society. 
In a similar way it is urged that we should buy all our 
sugar from our own producers. There is not much doubt 
that in ten years we could extend our production of sugar 
sufficiently to cover the demand for it, if we would but pay 



428 INTRODUCTION TO ECONOMICS 

a sufficiently high price to tempt labor and capital into 
the industry. Instead of sending $100,000,000 abroad to 
fructify Cuban industry, we could keep it at home among 
our own workingmen and capitalists. 

Let us see whether the foregoing argument will bear 
close examination. Assuming that we import $100,000,000 
of sugar in a year, how do we pay for it? Not with gold, 
but with bills of exchange representing the value of 
commodities that we export. 

Now suppose that we place so high a duty on sugar 
that importation ceases altogether. The immediate effect 
would be a reduction in the demand for foreign bills 
aggregating $100,000,000 per annum. Bills would, of 
course, fall below par; men exporting wheat and meat and 
cotton would get less for their products in consequence. 
The importation of commodities other than sugar would 
be stimulated, as we have seen, by the low price of bills. 
Exports and imports would have to be brought to a 
balance again, and this would come to pass through 
a shrinkage of exports and an increase of imports other 
than sugar. Perhaps we should buy annually $50,000,000 
more of these other imports than we did beiore, and export 
$50,000,000 less of wheat, meat, and cotton than we for- 
merly exported. The producers of sugar are indeed bene- 
fited by the elimination of foreign competition, but the 
producers of wheat, cotton, etc., are injured by the re- 
duced prices of exports, and the producers of other com- 
modities of which part of the supply is imported, are in- 
jured by the increase in importation of those commodities. 
Obviously enough, the evil ulterior effects of the losses of 
these two classes of producers cancel the beneficent ul- 
terior effects of the gains of the sugar producers. The one 
effect of the duty that stands out without any corre- 
sponding offset is that we shall pay a higher price for sugar 
— certainly a result that no one can ardently desire. 



THE REGULATION OF FOREIGN TRADE 429 

8. Protection of all industries is an impossibility. 

But suppose that the government places prohibitive 
duties on all imports. Will not this place all industries 
in a position where they may enjoy higher prices? A pro- 
tective system, it is often said, is unjust when it singles 
out a few industries and grants them special favors. But 
it is just if it favors all industries equally. 

An obvious objection is that if this were possible, if 
each industry were enabled to charge prices one hundred 
per cent higher, and each person, accordingly, received 
twice as large an income as he would otherwise have re- 
ceived, no one would secure any real benefit at all. If the 
income of each of us should be doubled, and we had to 
pay twice as much for everything that we buy, we should 
be no better off than we are now. But a more serious 
objection is this: no protective policy can raise the prices 
of all commodities. A duty can raise the prices only of 
articles that we are in the habit of importing. Now, if we 
import anything, we must export something to pay for it, 
and the export commodities must ordinarily represent as 
great a volume of values as the import commodities. 
Exports may exceed imports if a nation is making in- 
vestments abroad; they may be inferior to imports if a 
nation is borrowing from abroad. But in the long run 
such operations do not destroy the fundamental relations 
of exports and imports. Sooner or later the lending 
nation will have to take back an excess of imports, and 
the borrowing nation will have to find an excess of ex- 
ports. 

Now, the price of a commodity that we export must be 
lower in this country than in the countries to which it is 
sent. The prices of wheat and cotton in America must 
be less than the prices of the same articles in England, 
since we are constantly exporting them. It is manifestly 
absurd to suppose that by placing duties on wheat and 



430 INTRODUCTION TO ECONOMICS 

cotton imported into the United States we can raise the 
price of those commodities. Who would wish to import 
them into the United States? The duty on any export 
product is utterly ineffective. 

We have seen that restrictions on our imports restrict 
our exports also. They do this by making it hard for 
foreign customers to pay for our goods. And this re- 
striction on exports necessarily depresses their prices. 
An ''all round" system of duties, in spite of itself, im- 
poses a positive burden on as large a volume of industry 
as that which enjoys special favors under it. 

9. A plausible but fallacious argument for pro- 
tection is that high wages in America cannot 
be maintained in free competition with low- 
wage countries. 

Another argument for protective duties runs as follows: 
The American laborer requires a greater measure of the 
necessaries and comforts of life than the laborers of any 
other country. His wages must therefore be higher. It 
follows that American enterprisers, having higher wages 
to pay, are at a disadvantage as compared with their for- 
eign competitors. They must therefore sell their goods at 
higher prices; and this they would be unable to do if the 
foreign producer could bring his goods here without pay- 
ment of duty. From this point of view the tariff is re- 
garded as the bulwark of the American standard of living. 

This argument can no more bear analysis than the pre- 
ceding ones. All the export industries are able to pay the 
American scale of wages, and yet undersell their foreign 
competitors on foreign soil. These industries are ham- 
pered, not aided, by the protective system. Apart from 
the injury inflicted upon them by the restriction of the 
markets for their products entailed by import duties, 
these industries are rendered less profitable by the fact 
that many of their expenses are increased by the tariff. 



THE REGULATION OF FOREIGN TRADE 431 

Wheat and cotton growers are compelled to pay higher 
prices for agricultural implements, lumber, fertilizers, and 
other supplies because of the protective duties. The 
duties on iron and steel increase the costs of railway 
building and are reflected in higher freight rates, which 
represent a deduction from the net gains of the producers 
of the commodities that are carried to the ports by rail. 
If restrictions on imports reduce the amount of freight 
carried to this country from Europe, many ships are com- 
pelled to cross the ocean in ballast to carry away our 
exports; and this means that the exports have to pay 
ocean freights covering the costs of a return voyage, in- 
stead of a single passage of the ocean. Now, when we 
consider that in spite of all these disadvantages the export 
industries can retain the home market and invade foreign 
ones, we see clearly that a protective tariff is not needed 
to maintain the American rate of pay in all industry, 
although it may be necessary to maintain that rate in 
special industries — industries in which our advantages 
for production are less telling than they are in those in- 
dustries that have succeeded in conquering a place for 
themselves in foreign markets. 

10. A policy which draws labor from the fields 
that are of greater natural productiveness to 
fields of lower natural productiveness tends 
to reduce wages. 

In order to gain a clear view of the relation of a protec- 
tive duty to the rate of wages we must return to funda- 
mental principles. In any country, as was shown in earlier 
chapters, wages are determined by the marginal produc- 
tivity of labor. We will represent the various opportuni- 
ties for employment that a country like the United States 
affords by the symbols A, B, C, and D. A may stand for 
a group of industries in which we have exceptional advan- 
tages over foreign countries. B stands for a group of in- 



432 INTRODUCTION TO ECONOMICS 

dustries in which our advantages are less, C one in which 
they are still less, and D the group of industries in which 
they are least of all. When our population is so small that 
all our labor can be engaged in the group represented by 
A, wages will be at their maximum. When our population 
increases so that some of the labor will have to be set at 
work in group B, the wages of all labor must decline to 
the level of productivity in that group. We will suppose 
that population has increased up to a point where the op- 
portunities represented by A and B are fairly well manned, 
and wages are determined by the productivity of labor 
in B. 

With wages thus determined, it is clear that no em- 
ployer, without governmental aid, can afford to hire 
labor to exploit the opportunities represented by C and 
D. This would necessitate paying labor in C and D as 
much as it produces in B, and that, by hypothesis, is 
more than it produces in C and D. 

Now let us suppose that a political party is in power 
which holds the belief that we should produce everything 
that we consume — that is, that the opportunities repre- 
sented by C and D should be exploited as well as those 
represented by A and B. Labor must be drawn away 
from A and B and set at work in C and D. This involves 
the necessity of compensating enterprisers in some way 
for the disadvantages under which they will operate in C 
and D. Either wages must be reduced in A and B, or 
some form of subsidy must be granted to C and D. 

The commodities that the industries composing C and 
D will produce have been hitherto, we assume, obtained 
from abroad through exchange for commodities produced 
by A and B. The government now renders this difficult 
by placing high duties on the former class of commodities. 
This means that producers in the groups A and B — 
both employers and workmen — must pay higher prices 



THE REGULATION OF FOREIGN TRADE 433 

for what they buy. They do not receive higher prices for 
what they sell; in fact, they receive lower prices, as this, 
we have seen, is the effect of protective duties on export 
industries. It appears, then, that part of the disadvan- 
tage of producers in C and D is removed by reducing 
wages Cestimated in purchasing power) in A and B. 

After the duty has gone into effect and the prices of 
commodities that can be produced by C and D have risen 
sufficiently, enterprisers will be able to hire labor at the 
wages prevailing in A and B, and establish industries in 
C and D. So far as the remaining laborers in A and B 
buy the products of C and D, the difference between the 
price which they pay for those products and the price that 
they would pay if they were permitted to import those 
products duty-free is a tax paid not to the government, 
but to the producers in C and D, to enable the latter to 
remain in business. It is an uncompensated deduction 
from the natural earnings of the laborers in A and B. 
Their wages have been reduced; nor are the workers in 
C and D paid as much, estimated in purchasing power, 
as they would have received if they had been allowed to 
remain in A and B under the earlier conditions. The net 
effect of the imposition of the duty has been to saddle 
the self-supporting industries, A and B, with the support 
of the pauper industries, C and D. Yet the inventors of 
this poHcy have the effrontery to tell laborers in A and B 
that this policy is the bulwark of their high rate of wages ! 

The principles involved in the illustration may be 
stated in the following general terms: Wages in any 
country will be at the highest point when all the labor of 
that country is concentrated in the industries in which its 
relative advantages over other countries are greatest. If 
there are no protective duties whatsoever, employers will, 
as a rule, seek out the industries in which their country 
has the greatest relative advantages. Protective duties 



434 INTRODUCTION TO ECONOMICS 

enable other industries to exist, but only through taxing 
the more productive industries for their support. Protec- 
tion as a permanent policy means a slight reduction of 
money wages, and a greater reduction of wages estimated 
in purchasing power. Instead of a bulwark of the stand- 
ard of living, protection is a serious menace to it. 

11. The strength of the protectionist policy con- 
sists largely in the fact that the good effects 
of the policy are more easily perceived than 
the evil effects. 

The arguments for protection that have been discussed 
so far are all manifestly fallacious. They are not there- 
fore to be despised, since to hosts of men they appear to 
be absolutely irrefutable. And this, as Bastiat, a great 
French economist, was wont to say, is because the average 
man is unable to weigh the unseen effects of an economic 
policy against the effects that are seen. If we place a 
high duty on imported fabrics, the resultant high prices 
enable a new industry, employing thousands of workmen, 
to be established. This is the effect that is seen, and 
considered in itself, is wholly good. Every purchaser of 
the fabrics throughout the land is compelled to pay higher 
prices for them; but this effect is only dimly seen, if at 
all. In itself, it is wholly evil. Since part of what the 
new industry receives in this way from the public merely 
compensates that industry for the natural disadvantages 
under which it labors, it follows that the aggregate net 
gain to the industry is less than the aggregate net loss to 
the public. Again, the national production of wealth is 
increased by the amount that the new industry adds, 
and this effect of the duty is one that is seen. The na- 
tional production is reduced by the amount that the labor 
and capital diverted to the new industry would have 
produced elsewhere; this effect is not seen. Yet the re- 
duction in national production that the duty entails is 



THE REGULATION OF FOREIGN TRADE 435 

greater than the increase due to it, since labor and capital 
are diverted from the branches of production enjoying 
greater natural advantages to branches enjoying lesser 
advantages. 

, 12. Protection increases the productiveness of 
labor and capital if it drives labor and 
capital out of the less productive into the 
more productive fields. 
In the foregoing discussion the assumption has been 
made that when left to themselves enterprisers will seek 
out the industries enjoying the greatest natural advan- 
tages. On this assumption, all that government can do 
is to force industry into the less productive fields — a 
policy that can result only in reducing the national pro- 
duction. 

Now, while the assumption is ordinarily defensible, it is 
not universally valid. Enterprisers do not always know 
what fields offer the highest rewards. Furthermore, even 
if an enterpriser suspects that a given field, hitherto unex- 
ploited, would offer rich returns, conservatism may deter 
him from abandoning a field in which he is already gain- 
ing profits for a field in which he may gain larger profits, 
but in which he may also incur losses. 

The men who govern a nation may be more far-sighted 
and more progressive than the business men of the same 
nation. The former class of men may become convinced 
that certain fields of production will be profitable long be- 
fore the latter class will venture into those fields. The 
government, by placing duties upon the products that 
those fields might yield, makes success a certainty. Once 
the new industries are established, the duties can be re- 
moved without destroying them. The industry of the 
nation is enriched by the addition of fields of employ- 
ment that are as good or better than those already under 
exploitation. 



436 INTRODUCTION TO ECONOMICS 

It must, of course, be borne in mind that this case is a 
rare one. It is not often that the statesman knows more 
about business than the body of business men themselves. 
Where, however, the government is manned by ofhcials 
of a race intellectually superior to that of the governed, 
the national industry may be furthered in the way de- 
scribed. 

13. Protection may enable an industry of more 
than normal productiveness to surmount 
initial obstacles to success. 

Even when there exists no superiority of foresight on 
the part of those who make up the government, a govern- 
ment may often succeed in diverting industry from fields 
in which the natural advantages are less to fields in which 
they are greater. The United States has always pos- 
sessed great natural advantages for the production of 
iron and steel. What it lacked, in its early period, was 
training in the art of working metals. The enterpriser 
was unacquainted with the best processes, and he had to 
use labor that had not acquired the skill and the tradi- 
tions necessary for efficient production. 

Now, the only way to acquire an art is to practice it. 
We had to make iron for a long time before we could be- 
come adepts in the art. A generation might have sufficed 
for establishing the industry in a particular locahty; but 
what enterpriser would have undertaken to produce at a 
loss through a generation in order that some other en- 
terpriser might ultimately conduct the business with a 
profit? Obviously, the case demanded governmental aid; 
and the government did indeed come to the aid of the 
industry, through the imposition of duties on imported 
iron and iron wares. 

Long before the end of the nineteenth century the iron 
industry had become well estabhshed in certain parts of 
the East. It was still a new industry in the South and 



THE REGULATION OF FOREIGN TRADE 437 

in Colorado. Although the Pennsylvania industry might 
have been able to get along without duties, it was urged 
that the newer centers still required protection. Was it 
not better to over-protect the established centers than to 
expose the newer centers to the full effects of foreign 
competition? 

14. When an industry is well established within 

a country, protection becomes unnecessary. 
After an industry has been well established within a 
country, it migrates without great difficulty to other parts 
of the same country, if natural conditions warrant. When 
the iron industry has been established in Pennsylvania, it 
readily migrates to Alabama or Colorado, if natural condi- 
tions are as good as they are in Pennsylvania or better. 
Processes that are in use in Pennsylvania can be trans- 
ferred without cost to the other regions; a body of work- 
ers can be induced, without great difficulty, to migrate 
with the industry. There is far less reason for giving 
governmental aid to the newer centers than there was for 
giving it to the original one. Accordingly, we may say 
that it may be advantageous to protect an industry until 
it is well established within the national domain; if it is 
of a character that fits it for existence there, it will ex- 
tend itself to other regions even if protection is with- 
drawn. 

15. In practice it is difficult to determine when 

protection should be withdrawn from an 

industry. 
When an industry has become firmly established, fur- 
ther protection is inexpedient and unjust, as it enables the 
industry to levy upon other industries that are self-sup- 
porting a tribute that it does not need. Here a practical 
difficulty arises. How can we determine just when an in- 
dustry has passed through the period of infancy, and 
therefore should be left to shift for itself? We cannot 



438 INTRODUCTION TO ECONOMICS 

find out from those who are engaged in the industry, since 
they are naturally desirous of a continuance of pubhc aid, 
even though they do not need it; and those who are not 
engaged in the industry cannot tell. 

At the annual banquets of the various manufacturers' 
associations, the boast is frequently made that we can 
manufacture more cheaply than any other nation on 
earth. But if Congress proposes to reduce duties, the 
same men soberly declare that our industries will be 
ruined if this is done. And shall Congress, in its search 
for truth to enlighten it, appeal from the manufacturers 
pleading soberly the handicaps under which they labor to 
the manufacturers off their guard and intoxicated with 
success? The fact is, it is almost impossible for a gov- 
ernment to determine just when a protective duty can be 
removed. As a result every nation retains many such 
duties long after they have lost all efhcacy for doing any- 
thing but harm. Accordingly, there is good reason for 
the view that reckless experimentation in the establish- 
ment of new industries is to be avoided. 

16. The establishment of industries that will never 
be able to maintain themselves without pro- 
tection should be avoided. 

A stronger reason for cautious action lies in the fact 
that an industry established by the aid of a protective 
duty may never develop sufhciently to maintain itself 
without governmental aid. The natural conditions upon 
which it is based may be so unfavorable, relatively to the 
conditions in other countries, that the industry, if estab- 
lished, will be destined to remain forever a burden upon 
the public — a pauper industry. Let us suppose that in 
a given branch of industry a commodity can be produced 
here at a cost of $i, while it can be obtained from abroad 
for fifty cents. Without government aid, no enterpriser 
can afford to undertake its production. Now, let us 



THE REGULATION OF FOREIGN TRADE 439 

assume that a statesman, eager to see the United States 
producing every possible kind of goods, succeeds in plac- 
ing a duty of fifty cents on the imported article. The 
price to consumers must then rise to $1, a price sufficient 
to induce American enterprisers to produce the goods. 

After all the initial difficulties, such as training a force 
of men, establishing market conditions, etc., have been 
overcome, the cost of producing the article may fall to 
seventy-five cents, and remain there. This is the natural 
American cost of it. If the duty is removed, the foreign 
article will again be sold for fifty cents. The men who 
have put their capitals into the industry will have to 
close down their plants and discharge their workmen. 
The buildings and machinery used in the industry will 
probably be worth almost nothing for any other purpose. 
The skill acquired by the workmen, at great cost of time, 
perhaps, will be equally worthless. The removal of the 
duty, therefore, involves the ruthless destruction of what 
to those who have put their capital and skill into the 
industry are bona fide means of wealth production, 
although from the national point of view the industry 
makes no net addition to wealth, but rather leaves us 
poorer than we should be if the industry were dismantled. 

The question naturally arises, is it right to call an in- 
dustry into existence by governmental action, and later 
abandon it to the mercies of foreign competition? There 
can be but one answer: It is not right. The government 
did wrong in calHng into existence an industry that would 
never be able to survive unaided. It does wrong again 
when it abandons this ill-begotten industry to die of 
starvation. If, however, the industry is not abandoned, 
it is a perpetual expense to the self-supporting industries 
of the country. A human pauper dies in the end, but a 
pauper industry may live on forever. 



440 INTRODUCTION TO ECONOMICS 

17. Protection may serve a useful purpose in en- 
couraging the development of industries that 
make no drain upon the natural resources 
of a country, and retarding the develop- 
ment of industries that destroy such re- 
sources. 
A protective tariff may sometimes be defended on the 
ground that it preserves the natural resources of a country 
against wasteful exploitation. If the government does 
not restrict international trade, we may, as a rule, assume 
that enterprisers will seek out the fields in which a given 
quantity of labor and capital will produce the largest 
amount of value, or the fields in which our advantages 
over foreign countries are greatest. Let us suppose that 
one of those fields is the growing of wheat. In most parts 
of the United States wheat culture represents a heavy 
drain upon the fertility of the soil. Land devoted to con- 
stant wheat cropping becomes almost exhausted in a gen- 
eration. Accordingly, when one sells a bushel of wheat, 
he sells not only the product of his labor and capital, but 
a part of the natural heritage of his country. But why 
should he care? After his field is worn out, his years will 
probably be few. The next generation may be left to 
repair the wastes of this generation. 

Let us assume that coal and iron mining and the pro- 
duction of petroleum are other industries in which we 
have great natural advantages. Enterprisers, if left to 
themselves, would employ vast amounts of labor and 
capital in exploiting these natural resources. Every year 
we should send away from our country these commodities, 
representing not merely the annual product of our labor 
and capital, but also a part of our irreplaceable natural 
wealth. In a few generations we should be, as a nation, 
impoverished. 

We have seen that protection places a burden upon the 



THE REGULATION OF FOREIGN TRADE 441 

industries in which we have, for the present, great natural 
advantages, in order to build up industries in which our 
natural advantages are less. If the industries that are 
naturally most productive are of the kind that waste the 
natural wealth of the country, it is a statesman's proper 
policy to impose burdens upon them and so reduce the 
extent to which they are carried on, in favor of industries 
which involve no waste of resources, even though the 
annual production of wealth is thereby diminished for a 
time. 

The same argument, of course, condemns protection 
under other circumstances. According to conservative 
official estimates, we are using up, each year, four times 
as much lumber as we are growing. The rising price 
of lumber stimulates the activity of the woodsman to 
greater and greater remorselessness. Our mountains are 
denuded, and the waters, formerly held back by the forest 
covering and allowed to feed the rivers with regular flow, 
now sweep down the slopes in devastating flood. Obvi- 
ously, we should endeavor to stimulate importation of 
lumber ; if necessary, we should give a bounty on imports, 
that the price of lumber might be reduced and our few 
remaining forests saved. But the destroyers of our natu- 
ral heritage demand protection in their pernicious pursuit, 
and we accord it to them. 

18. Protection may serve the purpose of encour- 
aging the development of industries that 
are favorable to the health of the laborer. 

If extractive industries, prosecuted too relentlessly, 
waste the natural wealth of a country, manufacturing 
industries, prosecuted in the same way, waste its men. 
The population of a manufacturing center does not 
usually compare favorably, in health and vigor, with the 
population of rural districts. Indeed, it is doubtful 
whether an exclusively urban, manufacturing population 



442 INTRODUCTION TO ECONOMICS 

can in the long run escape physical degeneration. It 
might therefore be good poKcy in a country so largely 
devoted to manufactures as England to impose protective 
duties on imported agricultural products, with a view to 
increasing the proportion of the population employed 
upon the land. This would indeed burden the manu- 
facturing population; it would for many years reduce the 
product of the national industry. But in view of the 
ultimate effect upon the character of the population, this 
policy might be a good one from the point of view of the 
statesman, who must consider not merely the prosper- 
ity of this year and next, but also that of the remotest 
generations. 

19. A country should be able to provide itself with 
means for producing commodities essential 
to the successful conduct of a war; and in 
many cases can make such provision most 
conveniently through protection. 
A protective duty is defensible when it serves to main- 
tain facilities for the production of articles of national 
necessity, the supply of which might be cut off by war. 
War vessels can be built in Great Britain at far less cost 
than in the United States. In time of peace we should 
make important savings by having our war vessels built 
in Great Britain. If we were engaged in a war, however, 
we could not have warships built in Great Britain, 
whether that country were hostile or neutral. Yet it 
is precisely at such a time that we should most need to 
increase our navy. Prudence therefore demands that we 
should provide ourselves, in time of peace, with estabhsh- 
ments capable of turning out warships; and this involves 
giving them work to do. 

It is a moot question whether the creation of facilities 
for constructing merchant ships stands on the same foot- 
ing. In former times, certainly, a merchant fleet was an 



THE REGULATION OF FOREIGN TRADE 443 

indispensable auxiliary to a fighting fleet. The* merchant 
fleet furnished trained seamen, and many merchant ves- 
sels were capable of speedy transformation into warships. 
In the Great War some fast merchant ships were pressed 
into service as auxiliary cruisers, and vast numbers served 
as transports and supply ships. 

It is, however, a relatively small proportion of com- 
mercial shipping that is adaptable to use in war. Obvi- 
ously public aid based on motives of national defense 
should be narrowly restricted to shipping of this charac- 
ter. Moreover, the tendency of the times is toward the 
restriction of naval warfare. At a time when the chief 
naval powers join in agreements to sink a considerable 
part of their war vessels, there is something illogical in a 
policy of public aid for the construction of ships that 
might serve as auxiliary war vessels. 

Many industries that are not designed directly for the 
supply of articles of military necessity may be placed in 
the same class. In order that we may have high explo- 
sives in sufficient quantity for war, it is necessary to 
develop our facilities for making coal tar dyes, which are 
» based on the same material as high explosives. In order 
that we may be able to construct ships and produce guns 
and other instruments of war, we must have men who 
are trained in metal working; and if there is no other 
way of maintaining such a force of workmen, we should 
create and maintain an iron and steel industry through 
protective duties. It is, however, to be borne in mind 
that the maintenance of an industry large enough to 
cover all the demand for iron and steel in time of peace 
cannot be urged on grounds of national defense. 



444 INTRODUCTION TO ECONOMICS 

20. A policy which aims to make a country com- 
pletely independent of the products of other 
countries is more likely to create weakness 
than strength in war. 
There are some writers who extend the principle of 
national self-sufficiency to an unwarranted extreme. They 
would have every nation produce practically every article 
that it consumes, in order that in time of war there 
might not be the least interruption of supplies. These 
persons exaggerate the dependence of one country upon 
any other country against which it may at some time 
wage war. England, every one knows, does not produce 
enough grain to feed her population. And this fact ex- 
posed her to great danger during the Great War. There 
were indeed times, during the period of greatest sub- 
marine activity, when no one could be absolutely certain 
that England would not be forced out of the war. 

Yet the difficulty was overcome. The technical abili- 
ties at the command of a modern nation at war are so 
great that the appearance of any new weapon of offense 
quickly evokes means of defense to neutralize it. Eng- 
land found means in the end to assure herself of ade- 
quate supplies, in spite of the submarine. Germany, 
though cut off from vital sources of supply, did not 
succumb for that reason, but through want of military 
resources adequate to withstand her increasing number 
of enemies. 

I The strength of a nation in time of war does not de- 
pend upon its abihty to produce everything that its in- 
habitants consume. Rather, it depends upon the valor 
and number of its men, and upon its general wealth. 
Other things equal, a rich nation will overcome a poor 
one in war. Great Britain has proved formidable because 
of her wealth. Now, the endeavor to make a nation 
absolutely self-sufficing would end in making it much 



THE REGULATION OF FOREIGN TRADE 445 

poorer than it would be if it used its resources in a more 
economical way. If England had pursued throughout 
the nineteenth century a policy of self-sufhciency, she 
would have been forced to content herself with a limited 
population and a modest industry. Instead of holding 
the role of the most powerful European state, she would 
be little more than a satellite of the more populous states 
of the mainland. 

21. Duties imposed by way of retaliation are 
seldom advantageous to the country that 
imposes them. 

One further possible justification of duties designed to 
discourage importation requires examination. Other 
countries impose duties upon American products crossing 
their borders. Therefore, it is said, we should impose 
import duties on the products of such countries, by way 
of retaliation. Let us see whether this position is tenable. 

If England were to place a high duty on American 
meats, the persons who would be injured most seriously 
are the English consumers of meat. The English producer 
of meat would gain an advantage, but this, under ordi- 
nary circumstances, would not be commensurate with the 
loss to the English consumer. The world demand for 
American meat would be somewhat reduced, and this 
would reduce the price of it slightly. A small injury, 
therefore, would be infhcted upon the American producer 
of meat. 

Now let us suppose that in retaliation we levied ex- 
traordinary duties on British woolens. The chief sufferer 
would be the American consumer of woolens. The Ameri- 
can producer would gain, but not commensurately. The 
world demand for Enghsh woolens would be reduced, 
and this would shghtly reduce the price of them. Thus, in 
order to punish England for inflicting a large loss on 
British consumers and a small one on American producers, 



446 INTRODUCTION TO ECONOMICS 

we should be inflicting a large loss on American con- 
sumers and a small one on British producers. 

But retaHation is war, and in war the petty rules of 
logical conduct are not often observed. The important 
question is this: would the policy of retaliation effect its 
purpose? Would it compel England to remove the ob- 
noxious duty? In all probability, no. After the duty on 
meat had been in force for some time, British producers 
would increase their facilities for producing that article. 
To remove the duty and expose to the mercies of foreign 
competition the men who had invested their capital in 
good faith would be a policy as unjust as it would be 
unpopular. Similarly, American enterprisers would e:^- 
tend their facilities for producing woolens, and this would 
give them an equitable claim to a continuance of the 
duty. The only result of retaliation is the institution 
of permanent protection. If permanent protection is 
desirable, it should be undertaken without reference to 
the way in which a foreign government conducts its own 
affairs. If it is undesirable, it should not be undertaken 
at all. 

22. Summary. 

Protective duties may be defensible (i) when they make 
possible the introduction of an industry which in a reason- 
able time will compare favorably in productivity with in- 
dustries that are already self-supporting; (2) when they 
preserve the natural resources of a country from wasteful 
exploitation; (3) when they preserve the vigor and pro- 
gressiveness of the population through the maintenance 
of a just balance between manufacturing and agriculture, 
city and country; and (4) when they make possible the 
maintenance of industries that add materially to a 
country's strength in time of war. In any case such 
duties are a burden upon the national wealth, at the time 
when they are instituted, and often for an indefinite time 



THE REGULATION OF FOREIGN TRADE 447 

thereafter, and whether the benefit to be gained is a due 
compensation for the burdens involved is a question de- 
manding in each case careful consideration. Duties that 
are designed to raise wages or to increase the national 
wealth by building up industries for which we have no spe- 
cial advantages, are founded in a delusion. They are 
rendered possible only by the fact that the ordinary mind 
does not weigh their unseen disadvantages against the 
advantages that are patent to view. 



CHAPTER XXI 

THE RELATIONS OF GOVERNMENT TO THE 
ECONOMIC ORGANIZATION 

1. The economic and the legal systems of a coun- 
try are, in a measure, interdependent. 

The economic world with the study of which we have 
been engaged is a world of free private enterprise. Its 
motive forces are the acts of individuals, each seeking to 
further his own material interests. When such individuals 
buy or sell material possessions or personal services, they 
take little thought of the interests of society as a whole, 
and are little concerned with the wishes or the will of 
society. Yet the will of society plays a part in all these 
transactions, for they are shaped with tacit reference to 
the law. The individual is free to pursue his own interests 
only within the limits set by the positive law of the land. 

If we attempt to contrast the present economic state 
with the state that would probably exist were there no 
political organization of society, we shall realize that the 
will of society, as expressed in the acts of government 
(employing the term in its broadest sense), has played an 
exceedingly important part in economic evolution. With- 
out institutions, either customary or legal, assuring to 
each man the undisturbed possession of material goods 
acquired in ways recognized as legitimate, economic life 
could hardly have developed beyond the hunting or, at 
farthest, the pastoral stage. Without institutions giving 
binding force to contracts for the future deUvery of goods 
and services, economic life could not have passed beyond 
the stage in which the small artisan produced goods, on 
his own account, for a narrow local market. Progress 

448 



THE RELATIONS OF GOVERNMENT 449 

in governmental institutions has been a necessary con- 
dition of substantial economic progress. On the other 
hand, it was in large measure progress in economic life 
that necessitated progress in governmental institutions. 
It was the development of trade that broke down the 
feudal system and made possible, first the absolute mon- 
archy and later representative government. Pohtical 
institutions may long resist the forces of economic change, 
but sooner or later they yield. Some of the most serious 
practical problems of to-day have their origin in the fact 
that political evolution has not kept pace with economic. 
Our political machinery, which developed under simpler 
economic conditions, appears in many instances incapable 
of maintaining justice under present complex conditions. 

2. The basis of economic policy in almost all 
modern states is free private enterprise, or 
laisser-faire. 

A government may limit its economic activities to the 
defense of private property and the maintenance of the 
obligation of contracts. It may assume the function of 
determining the conditions under which economic transac- 
tions are carried on, and may even interfere in their 
terms. It may engage directly in the production of goods 
and services. In the first case the government is said to 
pursue a ''let alone" or laisser-faire policy; in the second 
case, a regulative or ''paternalistic" policy; in the third, 
a socialistic policy. In general, the basis of modern eco- 
nomic policy is laisser-faire. It is true that the regulation 
of an industry by government is a frequent phenomenon, 
and the direct participation by government in the pro- 
duction of commodities and services is an important 
factor in economic life. In Russia under the Soviet 
government all industry was, in theory, socialized, al- 
though practical considerations dictated many conces- 
sions to the principles of free enterprise, as for example 



4SO INTRODUCTION TO FXONOMICS 

the recognition of permanent land tenure for the peasants 
and tolerated ''speculation," or trade. Nevertheless, an 
overwhelming majority of modern economic transactions 
are carried on by private individuals, subject to no direct 
interference on the part of the government. 

The question may arise whether the existence of protec- 
tive tariffs in most of the countries of the world does not 
make it necessary to qualify the statement that laisser- 
faire is the basis of modern economic policy. In effect, 
the United States government prevents us from buying 
English steel, and compels us to buy steel of American 
manufacture. Yet the method by which it does this does 
not resemble the method of governmental regulation, to 
be discussed below. The government imposes the condi- 
tion that every ton of steel crossing our borders shall pay 
a certain tax. This condition met, the steel becomes an 
article to be dealt in freely. In buying or selling it men 
consult only their self-interest. The imposition of the 
duty creates a steel industry in this country; but the 
method by which this is done is very different from the 
method of governmental production. Prices are en- 
hanced; and this leads individuals, in the pursuit of their 
private interests, to engage in steel production. The gov- 
ernment, as it were, creates a favorable soil in which free 
enterprise may flourish. We may, therefore, say that the 
existence of customs barriers does not render necessary a 
qualification of the statement that the economic policy of 
modern governments is based upon the principle of laisser- 
faire, or free enterprise. 

3. The question whether the system of free private 
enterprise is conducive to a high degree of 
human welfare demands consideration. 

The system of free enterprise has been at once the sub- 
ject of extravagant praise and of savage criticism. Some 
writers attribute to it all the progress in civilization that 



THE RELATIONS OF GOVERNMENT 451 

the last centuries have witnessed. To these writers every 
encroachment by government upon the domain now oc- 
cupied by private enterprise is fraught with grave dan- 
gers. Other writers regard the system as wholly corrupt, 
and hope to see it replaced either by a system under 
which all economic activities are minutely regulated by 
government, or by one in which the government itself 
carries on all production of wealth in behalf of society 
as a whole. 

An exhaustive treatment of these opposing views would 
carry us far beyond the scope of the present work. We 
may, however, consider briefly whether, on the whole, the 
system of free enterprise meets the tests of fairness and of 
social expediency. If it does this in the main, there still 
remains a distinguishable field in which individual enter- 
prise should be subjected to governmental regulation, and 
yet another field in which the government should take a 
direct part in the production of wealth. A part of our 
task must be to find the boundaries of the respective 
fields, if such boundaries really exist. 

4. From the point of view of production the sys- 
tem of free private enterprise has proved 
highly effective. 

There can be no question that the productive power of 
man has been immensely increased in the two or three 
centuries in which enterprise has been accorded a fair 
measure of freedom by government. Improvements in 
methods of production and the formation of large accumu- 
lations of capital have reduced greatly the amount of toil 
necessary for the maintenance of human life. The 
amount of commodities placed at the disposal of the aver- 
age man has been vastly increased. Rehef from toil and 
command over commodities are not tantamount to well- 
being; but they serve at least as a basis of well-being. 

It would be unjustifiable to ascribe the entire sum of 



452 INTRODUCTION TO ECONOMICS 

progress in production to freedom of enterprise. ^lany 
other causes have contributed to this progress; but there 
is no doubt that many inventions have been made with a 
view to the profits that might flow from them; and the 
wide introduction of improved processes of production has 
been largely the result of the pursuit of profit. 

^Moreover, the relative efliciency of tlie system of free 
enterprise, as compared with earlier systems, should not 
blmd us to the fact that it still falls far short of any 
reasonable sUmdard of production. Waste of natural 
resources, of capital and labor is present in every in- 
dustry'. IMuch of this waste may be obviated by more 
skilful management, but part of it is inherent in the com- 
petitive system. Competing enterprisers have two ob- 
jectives, the one, to supply their consmners, the other, 
to secure advantages over one another. Often the latter 
involves tlie application of labor and capital to unpro- 
ductive uses. 

5. From the point of liew of the distrihuiion of 
iceaJth the system of free private enterprise 
presents grave defeets. 

One of the patent results of the system of free enter- 
prise has been the formation of classes diftering greatly 
in their command over wealth. Inequalities in fortune 
were probably never greater tlian they are to-day. It 
cannot be said tliat tlie poor are poorer than they were 
in earlier stages of the world's histor\\ but it is quite 
possible that tlie ^^Tetchedness of tlie poor in our great 
and wealthy cities is greater than was the oise in earlier 
times. It is a fair inference from the law of diminish- 
ing utility tliat a unit of purchasmg power in the hands 
of a rich man does not afford so much satisfaction as an 
equivalent unit in the hands of a poor man. If our na- 
tional income were more equally distributed, the sum of 
our national happiness would be greater, for any given 



THE RELATIONS OF GOVERNMENT 453 

moment of time. Possibly the ultimate result of an 
equalization of income would be to reduce production 
and so in the end to impair the incomes of all. In that 
case there is a contradiction between the interests of the 
present and the future. We may conclude that as be- 
tween present inequalities and future economic decay 
the former is the lesser evil. None the less inequality 
is an evil in itself, and in each case can be justified only 
by its specific relation to the release of productive ener- 
gies, in the present or in the future. 

6. In the apportionment of profits among enter- 
prisers, the relation between inequalities 
and the interests of production is easily 
established. 
Under competition any enterpriser may engage in any 
branch of production, and create and sell wares to his 
best advantage. Any enterpriser may make a calculation 
of costs and prices in the various branches of production. 
If prices are high in one field, relatively to cost, enter- 
prisers in that field reap profits quite out of proportion to 
any superiority they may exhibit over enterprisers in other 
fields. That is an evil in itself, but it bears its own remedy 
with it. New enterprisers press into the field; the supply 
of the commodity is increased, and its price falls. Thus 
the high rewards given to enterprisers in the field are an 
inducement to the expansion of production; the low re- 
wards in another field give warning that less of the 
product of that field is wanted by society. The unequal 
treatment of enterprisers is the means by which society 
compels them to direct their forces in such a way as best 
to meet society's needs. The inequalities are salutary 
in their effects; when there is no longer an improper dis- 
tribution of productive energies, they cease to exist. In 
some instances, however, the enterprisers succeed in erect- 
ing barriers against the entrance of competitors, and thus 



454 INTRODUCTION TO ECONOMICS 

secure a character of permanence for their high profits. 
This is the typical case of monopoly. The consumers are 
forced to pay year after year prices quite high enough 
to encourage an expansion of production, but no expan- 
sion takes place. The evil of inequahty persists: the 
corrective influence is abortive. It is the constant en- 
deavor of a democratic economic pohcy to do away with 
conditions making for profits of this character. 

7. Inequalities in wages and interest operate under 

competition to correct themselves. 

If in any industry wages are above the average, due 
allowance made for relative agreeableness and safety of 
employment, labor tends to flow into that industry from 
industries in which wages are below the average. Wages 
then fall in the former industry and rise in the latter. 
The initial inequalities in wages signified that there was 
too much labor in some fields, too little in the others, 
and the very fact of inequahties of reward helped to 
correct this condition. Similarly, there is a tendency 
toward equality of rewards for invested capital. 

But just as enterprisers may corner a field and fix profits 
at a permanently high level, so a labor organization may 
raise barriers to prevent the natural flow of labor into a 
fruitful field, and an organization of financiers may estab- 
lish a high rate of interest in a fruitful field of investment. 
Such labor and capital monopolies are more difficult to 
maintain than monopolies engineered by enterprisers. 
In so far as they exist, they defeat the trend toward 
equal rewards for equal services, and are socially injurious. 

8. When general profits are high forces are set in 

motion which tend to reduce them. Similar 
corrective influences operate against high 
interest and wages. 
In times of rising prices it often happens that practi- 
cally all enterprisers, not merely those who are unusually 



THE RELATIONS OF GOVERNMENT 455 

efficient, reap important profits. Such general profits are 
in the nature of a windfall, and correspond to no addi- 
tional service performed. They emphasize economic ine- 
quaHty, an evil in itself. But they lead to an attempt 
on the part of every enterpriser to increase his produc- 
tion, in order to participate more freely in the common 
good fortune. The result is a competitive bidding for 
labor and capital and a forcing up of wages and interest. 

Similarly, if the scarcity of capital or the opening of 
new opportunities for investment raises interest to a high 
level, forces are set in motion that tend to draw it back. 
Saving is stimulated even among those who are not im- 
mediate beneficiaries of the high rates of interest, and 
those who are beneficiaries have increased incomes out 
of which to make new savings. Unusually high wages 
draw immigrants into a country, and if continued through 
a generation, may affect the natural increase in popula- 
tion. 

It is on the basis of such considerations that it is often 
argued that no political intervention is necessary even if 
profits or interest are inordinately high. Say that they 
are oppressively high; yet the vice carries its own cor- 
rection with it. This argument has much to commend it 
when it is apphed to normal conditions. Under abnormal 
conditions, as for example during a war or in the eco- 
nomic disorders following a war, the correction often 
lags too far behind the evil. At such times the regulative 
powers of the state are often required to control prices 
and incomes and to prevent the development of socially 
injurious inequalities. 

9. When the parties to a contract are unequal in 
skill and strength, injustice is likely to re- 
sult. 

An economic system based upon free enterprise will be 
just and socially expedient only when the parties to each 



456 INTRODUCTION TO ECONOMICS 

contract stand on a footing of substantial equality. In 
the first place, the buyer must know the properties of the 
goods offered to him as well as the seller knows them; 
the laborer must know the risks and inconveniences 
attaching to a given employment as well as the employer 
knows them. When an unscrupulous horse dealer foists 
upon an unsuspecting buyer an animal with a hereditary 
taint of character or defect of body, the social welfare is 
in some degree reduced. The seller receives wealth, not 
for his services, but for his rascality; the buyer parts 
with his money, not for utilities, but for '^ experience." 
If all trade were of this nature, as much of it was among 
the ancient Greeks, we should, like the ancient Greeks, 
regard trade and piracy as twin callings, 

10. Free enterprise results in approximate jus- 
tice only under competition. 

In the second place, the buyer must be in a position to 
deal with any one of several sellers, each acting independ- 
ently of the others, and the seller must be able to offer 
his wares to any one of several independent buyers. The 
laborer must have the option of selling his services to any 
one out of a number of independent employers, and the 
employer must have the option of selecting from among a 
number of workmen. In other words, competition must 
exist on both sides. Otherwise the seller or the buyer, 
the laborer or the employer, is in danger of being forced 
to accept terms that are manifestly unfair. 

Of the two conditions stated, the latter — the existence 
of competition — is the more important. If competition 
is active, the seller of wares will point out their good 
qualities, and his competitors will point out their bad 
ones. Even an ignorant buyer is thus in some measure 
protected against injustice. When one party to a con- 
tract has no competitors to fear, knowledge on the part 
of the other is of little avail. There is a certain town. 



THE RELATIONS OF GOVERNMENT 457 

which I can reach only by travehng over a particular 
railway line. The line is in very bad shape; tlie ties are 
rotten and the rails are light; the cars are old and un- 
sanitary. Travel on this line involves an unduly large 
measure of danger and discomfort. Yet I must buy 
tickets over the line, because I have no alternative. 

11. The government must regulate the conditions 
and terms of economic contracts when its 
failure to do so results in substantial in- 
justice. 

Now, if there were merely sporadic cases in which con- 
tracts are made under conditions that make possible a 
wide departure from fairness, there would be little need 
for governmental intervention. But when there is an ex- 
tensive field in which such conditions prevail, the need for 
governmental intervention becomes imperative. 

In early times the producer and the consumer were, as 
a rule, neighbors. The tailor and his customer lived in 
the same village. If the tailor worked under unsanitary 
conditions, the customer had a chance of knowing it. If 
the tailor substituted inferior materials, trusting to the 
customer's ignorance, the deception was likely to make 
itself known in the wearing of the garments, and react 
unfavorably upon the tailor's business reputation. Fair 
deaUng, under the circumstances, was a prerequisite of 
business success, and the man who dealt dishonestly 
sooner or later reaped the due harvest of his misdeeds. 

To-day the man who makes your clothes may live a 
thousand miles away from you. He may be suffering 
from an infectious disease as he works upon your gar- 
ments. You cannot know it. The milk that you drink 
may come from a dairy one hundred miles away, where 
no attempt is made to prevent its contamination with the 
germs of disease. The appearance of the milk gives you 
no warning of the fact. Only an expert can tell you 



4S8 INTRODUCTION TO ECONOMICS 

whether the goods you buy are honest and sanitary; and 
you can probably ill afford to employ a corps of ex- 
perts to investigate the hidden qualities of the things you 
buy. 

The workman in a large factory is in a similar position 
of helplessness. He cannot estimate the degree of dan- 
ger that unfenced machinery represents. He cannot tell 
whether ventilation is adequate, or whether dust and nox- 
ious gases are properly disposed of. Furthermore, he is 
often unable to judge correctly as to the number of hours 
that he can toil daily without undermining his health. 

Not less significant than the separation of consumer 
from producer has been the development of combinations 
of producers. In many fields, buyers have virtually only 
one seller to deal with. In this state of affairs, there is no 
way in which the consumer can enforce a demand for 
wares of good quality, if wares of poor quality are more 
profitable. The employee of a monopoly may know that 
unsanitary conditions prevail in its shops, but he may be 
unable to find other employment. Furthermore, the 
prices of monopolized products are Ukely to be unreason- 
ably high, and this means that the monopolist takes from 
the aggregate income of society a larger share than his 
services warrant. 

12. The government may he called upon to regu- 
late the quality of goods or of services. 

Governmental regulation of the quality of commodities 
was exceedingly common in the Middle Ages. The weight 
of the loaf of bread, the width and quality of fabrics, were 
determined by public authority. With the development 
of modern industry much of this regulation fell into dis- 
use. Competition was permitted to regulate the quahty 
of commodities as it regulated their prices. The mediae- 
val kind of regulation has, however, survived in a few 
instances, where the retention by a country of a valuable 



THE RELATIONS OF GOVERNMENT 459 

branch of trade forbids individualistic tampering with the 
traditional standards of quality. The Persian government 
endeavors to suppress the use of aniline dyes in the manu- 
facture of rugs, on the ground that the employment of 
these dyes will ultimately destroy the foreign demand for 
Persian rugs. The Japanese government inspects all 
mattings produced for export, and regulates their quahty. 

The regulation of the quality of goods in most modern 
states has for its chief purpose the preservation of the 
public health. The use of certain ingredients in foods is 
forbidden; the use of other ingredients is limited to cer- 
tain fixed proportions. An attempt is made to insure the 
production of many classes of goods under conditions 
limiting the risk of transmission of disease from worker 
to consumer. Some modest efforts are made to protect 
the consumer against the grosser kinds of fraud, such as 
short weights and measures. In the United States oleo- 
margarine may not be palmed off on the consumer for 
butter. But cotton and shoddy may freely be sold for 
wool; paper may be freely substituted for leather in shoe 
soles. There is so much difficulty in administering laws 
directed against such practices, that the government usu- 
ally follows the easy rule, caveat emptor, ''Let the buyer 
look out for himself." 

The regulation of quality is carried farther in the case 
of certain goods and services furnished by enterprisers en- 
joying a monopoHstic position. The quality of gas to be 
furnished to the inhabitants of a city by a private com- 
pany is commonly prescribed by public authority. The 
service of passenger transportation by street and steam 
railways is often subject to regulation as to quality. In 
these cases regulation is usually defended on the ground 
that the enterprises are of a gwa^z-public nature. But 
any enterprise which obtains a monopoly of a branch of 
production is, from an economic point of view, in the 



46o INTRODUCTION TO ECONOMICS 

same position. If a powerful monopoly controlled the 
iron and steel business of the United States, it might 
find it profitable to use ores rich in phosphorus or sul- 
phur in the production of iron destined to be transformed 
into steel rails. This would result in the frequent break- 
ing of rails and menace the safety of all travelers; it 
would therefore be necessary in the end for government 
to regulate the quality of steel produced. 

There is, of course, a danger that the government may 
go so far in the regulation of quality as to check legiti- 
mate improvements. It is seldom expedient to leave 
much latitude of judgment to administrative officials. 
That would be to open the door to corruption. Accord- 
ingly fairly rigid standards must be laid down, and these 
will resist change stubbornly. The progress of science is 
continually elaborating new tests of quality, and the best 
type of producer applies them as soon as they are known. 
Such tests would come into operation, in administrative 
practice, only after much time had elapsed. Obsolete 
tests and ''red tape" would somewhat slow up the prog- 
ress of industry. But in spite of this danger it must be 
admitted that the principle of regulation of quality is 
salutary, and that the scope of regulation is destined to 
extend itself In future. 

13. A government may regulate the prices of com- 
modities or services. 

Governmental regulation of the prices of commodities 
and services was also exceedingly common in the Middle 
Ages. In modern times such regulation is normally 
limited to the field of the so-called quasi-public enter- 
prisers. The charges of railway companies, of gas and 
electric light companies, of telephone and telegraph com- 
panies, and even of such petty enterprises as the carriage 
of passengers in cabs and similar conveyances, are com- 
monly regulated by law. Such regulation is not actually 



THE RELATIONS OF GOVERNMENT 461 

based upon any economic ground, but upon the legal 
ground that the enterprises in question perform functions 
that the state has often performed, use the public high- 
ways, or employ public powers in obtaining rights of way. 

From an economic point of view, all the enterprises 
mentioned except the last ought to be subject to govern- 
mental price regulation, because they are monopolies. 
Without such regulation, a railway company might, if it 
chose, levy such heavy charges upon the carriage of goods 
away from and into a particular locality as to destroy the 
business of that locality and reduce the value of property 
situated there to almost nothing. If the railway is the 
only means of transportation from a mining district, by 
raising rates it can reduce the profits of mine owners to 
nil and force the closing of the mines. It can then buy 
up the mines at a very low figure, and operate them prof- 
itably on its own account. True, this is an extreme case; 
yet it illustrates very well the evils that an unregulated 
monopolistic determination of transportation charges would 
entail. 

If a monopolistic combination succeeded in gaining 
complete control of the business of mining coal, its pow- 
ers for extortion would be as great as those of the railway 
in our example. What would one give rather than pass a 
Northern winter without coal? Not all that one has, 
but a good part of it. If we must inevitably see an ex- 
tension of monopolistic enterprise, as many believe, it is 
inevitable that we shall see an extension of the principle 
of governmental price regulation. 

In time of war the policy of price regulation Is applied 
over a wide field. In the uneasy state of the public mind 
buyers' panics are easily engineered, and may result in 
enormous losses to the public through inflated prices. 
Most governments, during the Great War, had to inter- 
vene for the control of the prices of various necessaries 



462 INTRODUCTION TO ECONOMICS 

of life. Bread, sugar, and coal were among the commodi- 
ties most generally subjected to pirce control. 

14. A government may regulate the conditions 
under which labor is performed. 

So long as economic organization remained simple, there 
was comparatively slight need for governmental regula- 
tion of the conditions under which labor was performed. 
A large proportion of those who toiled were their own em- 
ployers, and these could be counted upon to keep their 
work places in tolerably sanitary condition, and to limit 
their hours of labor and the intensity of their exertion to 
the degree that considerations of health demanded. 
Those who worked for wages enjoyed, as a rule, conditions 
as favorable as those of the workmen who were their 
own employers. The advent of the factory system 
changed conditions materially. Men, women, and chil- 
dren were congregated in great masses, under the supervi- 
sion of overseers, many of whom were bent upon getting 
the maximum possible service from the workers under 
them at whatever cost to the worker's health and hap- 
piness. Machinery took a place in the productive series, 
and the workers were forced to adapt themselves to the 
speed of the machines. Competition between manufac- 
turers led to a longer and longer working day, and to 
greater and greater intensity of effort. The worker, 
seeking employment, was in no position to stipulate that 
the working day should be limited to a reasonable num- 
ber of hours, or that the labor should not be so intense 
as to be destructive of the health of the laborer. 

Society, it is clear, cannot afford to see the vitality of 
its working classes sapped in an effort to raise to its maxi- 
mum the immediate production of wealth. An individ- 
ual employer may profitably pursue the policy of hiring 
a set of workmen, wearing them out in a few years, and 
replacing them by another set. From the viewpoint of 



THE RELATIONS OF GOVERNMENT 463 

» 

society this policy is as wasteful as it is cruel. The daily 
exertion of each man should be restricted to such measure 
that he may live a life of normal length, enjoying the 
normal number of years of health and usefulness. 

When laborers are associated in strong unions, they 
may be able, without governmental aid, to reduce the 
hours of labor to the measure that is desirable from a 
social point of view. Each organization is composed of 
workers of various ages, and there is a natural tendency 
to maintain a pace that is not too rapid for the older 
workers, hence not so rapid as to destroy the physical 
health of the younger men. 

But strong trade unions control only a small part of 
the economic field. Such associations are especially weak 
in industries employing large numbers of women and chil- 
dren, and these are precisely the classes that are most 
seriously injured by long hours of work. Hence it has 
come to be generally recognized that the conditions under 
which women and children work in factories ought not to 
be left to free contract. Hours of labor, for these classes, 
must be regulated by government. 

In almost every modern state some attempt is made to 
regulate by law the hours of labor of children employed 
outside of the household. Such regulation has been car- 
ried farthest in the states where the system of large scale 
production has long been established, as, for example, in 
England. In new industrial states, as in Japan, the regu- 
lation of the hours of child labor is only in its inception. 

The regulation of hours of labor of women employed 
under similar circumstances is also a well-established 
pohcy in the more advanced states. In the United States 
the progress of regulation has been slow, partly because 
of the failure of the public to recognize its importance 
and partly because the courts have been unfriendly to 
regulation, as abridging the right of contract. Yet a 



464 INTRODUCTION TO ECONOMICS 

t 

considerable number of states now have laws limiting the 
hours of women's work in factories and shops to a speci- 
fied number weekly — fifty-four hours or less. The regu- 
lation of hours of labor of men has as yet made com- 
paratively slight progress; the policy is, however, destined 
to extend its scope in the future. 

The regulation of other conditions of employment — 
ventilation, sanitation, the safeguarding of the worker 
against dangerous machinery, etc. — has encountered 
comparatively few positive obstacles. The field is, how- 
ever, so wide, and the work of legislatures so slow, that 
hundreds of thousands of workmen are to-day employed 
under conditions involving needless risk of mutilation and 
death. Still greater is the number employed under condi- 
tions that predispose the worker to disease. Progress in 
the direction of regulation of such conditions is steady, 
but dishearteningly slow. 

15. The government may regulate rates of wages. 

The regulation of wages is a policy very seldom em- 
ployed in modern times. Doubtless there are many cases 
in which wages are far below the level of productivity of 
labor; and in these cases it is manifest that injustice is 
done. To attempt to fix general wages by law, however, 
is to encounter grave difficulties. If in any industry 
wages were fixed at a level that seemed to the workers 
too low, the latter would feel justified in refusing to work. 
If the level of wages seemed to employers too high, they 
would feel justified in closing their shops. To force the 
laborers to abide by the rate determined by government 
would be to inaugurate an era of universal serfdom. Men 
would be compelled to work on terms fixed by others, 
and this is the essence of serfdom. To force employers 
to continue production, paying wages that seem to them 
unduly high, would be to confiscate property. In either 
case it is likely that economic progress would be checked. 



THE RELATIONS OF GOVERNMENT 465 

This does not mean that it would not be possible to se- 
lect certain industries, in which the laborer is most seri- 
ously exploited, and establish minimum wages there. If 
the rate were too low, some of the laborers could seek 
other employment. If the rate were too high, some of 
the employers could remove their capital to other indus- 
tries. With the shrinkage in the volume of the industry, 
the price of its products would rise, and this would enable 
the remaining employers to pay the rate of wages fixed. 
True, some of the workers formerly in the industry 
would be left without employment. Some means would 
have to be found for transferring them to other employ- 
ments. However this might be, such regulation, limited 
to a few fields, would encounter no insuperable obstacles, 
and might result in alleviating the distress of some of the 
most helpless members of society. In a number of states 
minimum wage laws for women and minors have been 
in operation for several years in specified industries. The 
experiments are not sufficiently wide in scope to offer 
much light on the general problem of governmental de- 
termination of wages. They appear to show quite con- 
clusively, however, that a decided improvement can thus 
be effected in the lot of the class of workers who are 
commonly most ruthlessly exploited. 

16. Governmental regulation of the relations of 
capitalists and enterprisers is, in some 
cases, necessary. 

Regulation of the relations between enterpriser and 
capitahst, or between borrower and lender, tenant and 
landowner, has largely fallen into disuse. In modern 
times the man who borrows capital is usually possessed 
of some property and of at least a moderate degree of 
business capacity. It may therefore be taken for granted 
that he will not subscribe to terms that are not to his 
advantage. If a man is willing to borrow for business 



466 INTRODUCTION TO ECONOMICS 

purposes capital at ten per cent, there is good reason 
for believing that the annual use of the capital is worth 
to him at least $io per $ioo. Accordingly, there is no 
reason why the public authority should interfere in the 
transaction. Many of our states do indeed have usury 
laws, limiting the rate of interest that may be paid. But 
these laws are seldom appealed to, except in cases in- 
volving petty personal loans, which are essentially differ- 
ent, in their nature from business loans. Here the need 
of regulation is obvious. Usually the borrower is poor, 
often ignorant, and temporarily in great straits. He 
falls an easy victim to extortion, unless the government 
intervenes in his behalf. 

Where the enterpriser is a corporate body, as is com- 
monly the case in large scale production, the relations be- 
tween those shareholders who are actually in control and 
those whose voice in the management is seldom heard, 
often need regulation. The small investor in a large cor- 
poration is often at the mercy of a group of large inves- 
tors, who manage the property in their own interests, not 
in those of the entire body of stockholders. Something 
akin to the confiscation of property takes place when the 
men in control of a corporation undertake a '' shaking 
out" of the "little men." In the end, doubtless, regula- 
tion will come, and the small investor in a corporation's 
stock will know whether he is buying property or shadowy 
hopes, and whether or not he will be permitted to keep 
what he has purchased. 

Where a small number of large landholders deal with 
a vast number of small tenants there is often opportunity 
for the oppression of the latter. The tenant who brings 
a tract of land into an excellent state of cultivation 
should not be evicted by the landowner without fair 
compensation. Justice demands that he should be per- 
mitted to retain his occupancy of the land until he has 



THE RELATIONS OF GOVERNMENT 467 

reaped the fruits of his labor. Upon the renewal of his 
lease he should not be compelled to pay an additional 
sum for the use of the productive powers that he has 
himself created. A wise landlord, it is true, will not deal 
unjustly with tenants who increase the productive power 
of his land; but not all landlords are wise. The tenant 
may, in some measure, safeguard his interests by the 
terms of the contract under which he enters upon his 
tenancy; but not all the conditions that may arise during 
a term of tenancy can be covered by a formal contract. 
Accordingly, the state, under the conditions assumed, 
may be called upon to regulate the relations of landlord 
and tenant in such a way that the latter may proceed 
confidently with the improvement of the land, knowing 
that he cannot be deprived of his due reward. No gen- 
eral problem of this nature has arisen in the United States. 
This is due to the fact that it is easy for any energetic 
cultivator to acquire land of his own. It is quite con- 
ceivable that at some future time, when the rising price 
of land and the resultant concentration of holdings have 
given rise to a permanent class of tenant cultivators, 
the regulation of the relations of landlord and tenant will 
assume great importance. 

Most foreign governments which have occupied them- 
selves with this problem have been forced to the conclu- 
sion that no permanent solution is to be found short of 
the restoration of ownership to the men who actually 
work the land. This may be effected either through free 
purchase and subdivision of estates by the government, 
or by compulsory purchase. In the economic disturbances 
following the Great War the great estates were sub- 
divided, either by purchase or by confiscation, in almost 
the whole of eastern Europe. 



468 INTRODUCTION TO ECONOMICS 

17. Governmental regulation does not change the 
fundamental characteristics of the existing 
economic system. 

The foregoing survey is sufficient indication of the 
fact that the regulative activities of government already 
cover a wide field, and we have excellent reason for be- 
lieving that the scope of such activities will in the future 
be greatly extended. In so far, we seem to be drifting 
away from an economic system based upon free private 
enterprise. It cannot be said, however, that the essen- 
tial nature of the existing economic system is thereby 
altered. That system is based upon private initiative; 
and though the government may restrict the field in 
which private initiative finds exercise, it does not bind 
initiative itself. The government may prohibit the pro- 
duction of certain articles. In so doing it warns private 
enterprise away from a limited field; but there remain 
other fields open. The government may fix the price at 
which a certain article may be sold, but this price must 
be left high enough to tempt private enterprise into the 
field; otherwise the article will not be produced. The 
government may prohibit the employment of certain 
classes of persons, and restrict the hours of labor of other 
classes. Private enterprise is still called upon to furnish 
employment, and the conditions may not be made so 
onerous as to exclude the possibility of liberal profits. 
A system of regulated enterprise is none the less a sys- 
tem of private enterprise. A range of choice and an 
opportunity for gain are left open to the enterpriser, 
and if enterprise is really active, it is forever creating 
new opportunities beyond the reach of regulation. 

It may appear that while the existing system of eco- 
nomic organization is in no danger of subversion through 
the extension of governmental regulation, it is in danger 
of being supplanted by a system of governmental enter- 



THE RELATIONS OF GOVERNMENT 469 

prise, or a socialistic state. We have already many ex- 
amples of direct production of commodities and services 
by the state; and we may predict an increasing number 
of such enterprises for the future. Must we therefore be- 
lieve that a time will come _when the state will enter all 
branches of industry, and organize the whole working 
population as a civil service corps? We shall get some 
light upon this question from a study of the reasons that 
have led to the direct participation of government in 
industry. From such a study we may draw inferences as to 
whether or not the same reasons will lead to an indefinite 
extension of the principle of governmental enterprise. 

18. A government may take over an industry for 
the purpose of securing a revenue from the 
profits of the industry. 

In some instances, the production of a commodity or a 
service is undertaken by government solely with a view to 
securing a revenue. This is the case with the tobacco 
monopoly of France and of some other countries, the salt 
monopoly in British India, and a few other public monop- 
olies. The profits of the business take the place of reve- 
nues that would otherwise be raised by taxation. The 
government of France, instead of operating a tobacco 
monopoly, might levy duties on the manufacture and sale 
of tobacco. If the policy of a government monopoly is 
resorted to, the product is sold to the pubHc at a price 
exceeding cost of production. Now, the government 
might, instead, place a tax on the private manufacture 
of the article. The manufacturers would add the tax to 
the price paid by the consumers. In either case the 
government would get a revenue and the consumer 
would pay a surplus above costs. In either case the 
consumer would bear the burden. Which is the better 
policy, then, a government monopoly or a tax on an 
industry conducted by private enterprise? 



470 INTRODUCTION TO ECONOMICS 

It might be that the manufacture and sale of tobacco 
could be carried on more cheaply by government than by 
private enterprise. In such a case the government could 
secure a larger revenue, at the same burden to the con- 
sumer, by operating the industry itself. But it is not 
very likely that the government could produce more 
cheaply than private enterprises. Men do not as a rule 
work so hard in public as in private employ, and they 
usually are paid more liberally. 

But tobacco is a product characterized by great differ- 
ences in quality. It would be extremely difficult to 
arrange a scheme of taxation which would make each 
grade pay as large a revenue as it would bear. It is not 
difficult for a government monopoly to fix the highest 
revenue price on each grade. This is the paramount 
reason why the monopoly is favored. It is a better in- 
strument of taxation than any regular tax would be. 

19. The government may assume control of an in- 
dustry for the purpose of regulating the 
quality or the price of the product. 

The assumption by governments of the sole right to 
coin money is an illustration of an industry undertaken 
by government for the purpose of regulating the quality 
of the product. Imagine the inconvenience of a currency 
composed of coins struck by all the private companies 
that mine gold or silver! Some would be light weight, 
some heavy; some would have much alloy, some little. 
Obviously, absolute uniformity and absolute conformity 
to well-known standards are essentials of a currency em- 
ployed in a modern state. And such uniformity and 
integrity of quality can be secured only when the coins 
are issued by an organ of society which regards the in- 
terests of society as paramount. Doubtless it costs more 
to coin money in government establishments than it 
would cost in private establishments. But this waste is 



THE RELATIONS OF GOVERNMENT 471 

insignificant as compared with the gains from a currency 
of unquestioned soundness. 

A similar reason has led to the nationalization of the 
railway in many countries, and to a popular demand for 
nationalization in other countries. If we could be sure 
that private railways would furnish good service, at 
equal terms to all, and at reasonable charges, we should 
never regard government ownership of railways as de- 
sirable. But of this we cannot be sure. We have tried 
regulation, and are still trying it; and it may be that we 
shall succeed in our endeavors to secure impartial and 
reasonable treatment of shippers and travelers. But when 
it is necessary to carry regulation to the point of fixing 
rates, quality of service, wages, profits — as we practi- 
cally do — there is very little room for private enter- 
prise to exhibit its most important virtue, initiative. Yet 
we cannot regulate less, and make sure of impartial and 
reasonable charges. It appears probable that we shall in 
the end make up our minds that the railway is to other 
business enterprises what the coinage is to other com- 
modities — an essential h'nk in almost every business 
transaction — and that its social aspects are of such para- 
mount importance that it ought to be operated directly 
by the government. 

A similar argument applies to the so-called municipal 
monopolies — street railway transportation, the furnish- 
ing of water and light, and the telephone service. If it 
is impossible to regulate the quahty and the price of 
service under private management, public management 
becomes necessary. 

20. Where the utilities created by an industry are 
not appropriable, government operation be- 
comes a necessity. 

In the foregoing instances there is no inherent necessity 
for public operation of industry. In the first case this 



472 INTRODUCTION TO ECONOMICS 

policy is adopted in lieu of a policy of taxation; in the 
other cases, in lieu of a poHcy of regulation. We come 
now to consider cases in which government enterprise is 
necessary, because it is the only means of securing certain 
important utilities for society. 

In some branches of industry, practically all the utili- 
ties created embody themselves in a concrete form, so 
that the producer is able to recoup himself for his costs 
of production through sale of the utilities to those who 
are to enjoy them. The utilities created by a shoe manu- 
facturer are embodied in the shoes; and the manufacturer 
can obtain from the user of shoes a price that will compen- 
sate him for his expenses. If the consumer will not pay 
enough to cover costs, the shoes ought not to be made, 
for there are no utilities arising from their making that 
the consumer cannot appraise. 

We may contrast with the utilities furnished by such 
an industry the utilities furnished by a lighthouse. These 
are scattered far and wide over the waters that are ren- 
dered safe by the light. They benefit every shipowner 
whose vessel sails in these waters; every passenger for 
whom the danger of death at sea is thereby reduced; 
every shipper who pays lower freights because of the 
smaller chance of the foundering of ships. In a year's 
time the utilities contributed by the lighthouse may far 
exceed its cost of maintenance. But if you or I were to 
erect a lighthouse, how would we collect pay for these 
utilities from the beneficiaries? Clearly, this is no field 
for private enterprise, and yet it is a field in which labor 
and capital may produce greater utilities than elsewhere. 
The government, as the representative of society, can 
alone afford to exploit this field. 

Again, an industry may produce some utilities that are 
concrete and appropriable, and some that are elusive, 
flowing freely to persons who cannot be made to pay for 



THE RELATIONS OF GOVERNMENT 473 

them. In a very slight degree this is true of all industries; 
but we are concerned only with cases in which this differ- 
entiation of utilities is well marked. We may take as an 
example common school education. The children who 
receive instruction are the immediate beneficiaries; they, 
or their parents, could be made to pay something for it. 
But all of us who wish a government of officials selected 
by intelligent voters; all of us who prefer intelligent and 
efficient employees to ignorant ones ; all of us who wish to 
enjoy the products of a rich and varied national produc- 
tion, — are the indirect beneficiaries. A great part of the 
total benefit from educating a child is reaped by persons 
not connected with him by ties of blood or personal 
interest. 

Now, if the benefit to the child is so great, and so 
clearly appreciated by him or by his guardians, that the 
entire expense of education can be met by tuition, we 
who are also beneficiaries may take our gains gratis. But 
if this is not the case — and, as a rule, it is not — we 
should be very shortsighted if we refused to contribute 
our share to the expenses of his education. From a social 
point of view the benefits of popular education far out- 
weigh the expenses of it; the expenses cannot in each 
case be assessed upon the beneficiaries; therefore the pro- 
duction of the utilities in question must be undertaken by 
government. 

In the foregoing cases the utilities created, though real, 
are not tangible, nor are they capable of definite measure- 
ment. There are other cases in which the utilities created 
are measurable, but yet can not be appropriated by the 
producer. Near one of our large cities there is an island 
which is capable of providing building lots for a large 
population. Until recently comparatively few persons 
could make the island their home, on account of the 
uncertainty and inconvenience of passage to the city. A 



474 INTRODUCTION TO ECONOMICS 

ferry service existed, but the boats were small, old, and 
slow. The owners of the ferry line could not furnish 
better service, however, because the increase in fares 
would not cover the increase in expense. 

The introduction of an efficient ferry service would 
have greatly increased the value of land on the island; it 
would have furnished an outlet to some of the surplus 
population of the city, and diminished the evils of over- 
crowding in tenements. These utilities might very well 
have been of sufficient annual value to offset the in- 
creased cost of service. But the private ferry company 
could collect no charge for them; therefore it could 
not make the improvement. The city, on the other 
hand, could very well afford to establish a satisfactory 
service to the island, since the city as a whole would get 
most of these elusive benefits, in addition to the fares it 
would collect from passengers. 

It is obvious that the same principle may be extended 
to a great many enterprises — street railways, steam rail- 
ways, etc. At any given time most of the utihties pro- 
duced by such an enterprise as a street railway system 
may be of such a character that a price can be charged 
for them. As the city grows in size and questions of 
transportation assume greater and greater importance, 
the utilities that are not appropriable increase in number 
and in value. In the end, these utilities may come to be 
of such significance that the transit system ought to be 
managed chiefly with reference to them. When this is 
the case public ownership ought to take the place of 
private ownership. 

Now, as population increases, the industries producing 
non-appropriable utilities, along with those that are appro- 
priable, become more numerous — or, more exactly, the 
non-appropriable element in utihty production becomes 
more important, relatively to the appropriable element. 



THE RELATIONS OF GOVERNMENT 475 

Accordingly, an expansion of public enterprise, in this 
direction, seems inevitable. 
21. When private enterprise is too weak to enter 
upon a productive field , government enter- 
prise is sometimes necessary. 
One further case in which public enterprise may enter 
the field of production may here be touched upon. Some- 
times private enterprise is not sufhciently daring or skill- 
ful to enter upon the supplying of utilities even when 
there is no obstacle in the way of charging a price for 
them. The government, if under the control of able ad- 
ministrators, may then increase the social welfare by 
undertaking production directly. When a country, long 
habituated to one mode of economic life, is suddenly 
compelled to adapt itself to new conditions, this superi- 
ority of public to private enterprise may manifest itself. 
In the last half of the nineteenth century many enter- 
prises were undertaken by the Japanese government, 
in fields ordinarily left to private business. As a class of 
enterprisers developed, the control of such business was 
gradually transferred to them. When, on the other hand, 
private initiative dies out in a people, owing to the weed- 
ing out of the more intelHgent and enterprising elements 
in the population, the government may gradually assume 
control of production and trade. Something of this 
nature occurred in the later years of the Roman Empire 
and in the decHning period of Venetian history. 

So long as there remains in society a large class of per- 
sons possessing enterprise and ingenuity, there is little 
reason for beheving that the extension of the field of 
public enterprise will really narrow the field of private 
enterprise. For the boundaries of the latter can be ex- 
tended indefinitely outward, so long as men have wants 
that remain unsatisfied. Public enterprise will wholly 
supplant private enterprise only when the latter has be- 



476 INTRODUCTION TO ECONOMICS 

come impotent to direct the supplying of the needs of 
society. 

22. Summary. 

The basis of the modern industrial system is free pri- 
vate enterprise; such apparent violation of the principle 
as a protective tariff represents does not alter its funda- 
mental truth. 

The system of private enterprise has proven highly ef- 
fective in the field of production; in the field of distribu- 
tion it is impossible to give an unquahfied opinion as to 
the justice and expediency of the system. Unregulated 
private enterprise gives rise to serious evils which demand 
governmental intervention. 

In general, wherever gross inequality appears in the 
bargaining power of parties to contracts, governmental 
regulation is necessary. The government may be called 
upon to regulate (i) the quality of commodities and serv- 
ices; (2) the price of commodities and services; (3) the 
conditions of labor; (4) the wages of labor; (5) the rela- 
tions between capitalist and enterpriser. 

Governments often participate directly in industry. 
The purpose of public enterprise may be merely the secur- 
ing of a revenue. This end may usually be better 
attained through taxation of private industry; hence 
extension of governmental enterprise to this end is im- 
probable. The government may take over an industry 
in order to regulate effectively the quality or the price of 
the product of the industry. Pubhc enterprise having 
this object is likely to become more common with the 
development of society. The government may take over 
industries, the utility-product of which is not readily ap- 
propriable. Public enterprise of this nature is also 
likely to increase in importance. The government may 
found industries when private enterprise is lacking in 
efhciency. 



INDEX 



Accidents, 207 et seq. 
Agricultural prices, 278. 
Agriculture, 157. 

American Federation of Labor, 227. 
Apprenticeship, 223 et seq. 
Arbitration, 232 et seq. 
Associated Press, 175. 

Bank, Ch. XVII. 

Banking, 12. 

Bank notes, 357 et seq.; 362; 

federal reserve, 360. 
Barter, 404 et seq. 
Bastiat, 434. 
Bills of exchange, 342; 347; 408 

et seq.; 424 et seq. 
Bimetallism, 312; 327 et seq. 
Bondholder, 368. 
Bonds, 368. 
Boycott, 229 et seq. 
Broker, 372 et seq.; 385, 
Building and loan association, 381 

et seq. 
Building industry, 143 et seq.; 151 

et seq. 
Bureau of Economic Research, 

215. 
By-products, 61 et seq.; 163 et seq. 

Capital, acquisitive, 242 et seq.; 

natural, 245; productivity of, 

Ch. XIII. 
Capital goods, 238. 
Capitalists, 19 et seq. 
Capitalization, Ch. XIV, 275 et 

seq.; of monopoly profits, 297; 

of land, 277. 



Checks, 345 et seq.; 350. 
Child labor, 131; 289; 463. 
Cities, growth of, 22. 
Classes, economic, 19; 23; 364. 
Clearing house, 175; 351 et seq.; 

362. 
Closed shop, 222. 
Clothing industry, 124. 
Coinage, 310 et seq.; 470. 
Collective bargaining, 231 et seq. 
Combinations, Ch. X; 19; 458; 

agricultural, 173. 
Competition, 16 et seq.; 23; 137; 

456 et seq.; foreign, 96 et seq.; 

100; 148 et seq.; limits on, 286; 

potential, 17 et seq.; 75. 
Concentration, Ch. IX; 10; as 

affected by diminishing returns, 

16S et seq. 
Conciliation, 233. 
Consolidation, 176 et seq.; effect 

of, on labor organization, 226 

et seq. 
Consumer's goods, 238. 
Consumption, 10. 
Contract labor, 291. 
Cooperation, 174. 
Corner, 78 et seq. 
Corporation, 159; 339. 
Cost, price determined, 100 et seq.; 

price determining, 100 et seq. 
Cost accounting, 140 et seq. 
Cost of living, 215 et seq. 
Cost of production, Ch, V; factors 

in, 55; relation to normal price, 

54 et seq.; variations in, 63 

et seq. 

477 



478 



INDEX 



Credit, 340 et seq.; efifect on prices, 

320. 
Credit instruments, 341 et seq. 
Creditor and debtor, as affected 

by price changes, 324 et seq. 
Crisis, 354 et seq. 
Cross freights, 181. 

Debtor and creditor, as affected 

by price changes, 324 et seq. 
Demand, 44 et seq. 
Deposits, 346 et seq.; 350 et seq.; 

362. 
Depression, 326. 
Differentiation, economic, 119 et 

sbq. 
Diminishing returns, Ch. VI; 10; 

as appHed to division of labor, 

132 et seq.; in agriculture, 107 

et seq. 
Discoimts, 347 et seq. 
Discriminations, 166. 
Distribution, 10 et seq.; 13; 187; 

452 et seq. 
Division of labor, 123 et seq.; 

160; as affected by diminishing 

returns, 132 et seq, 
Duties, protective, 418 et seq.; 

revenue, 418 et seq. 

Economic classes, 19; 23; 452. 
Economics, definition of, 8 et seq.; 

function of, 12; mediaeval, 17; 

123; 126; origin of, 11; social, 

21; 23. 
Economic system, characteristics 

of, IS et seq.; 23. 
Economistes, 12. 
Economy, exchange, 16. 
Economy of high wages, 148 et seq.; 

199; 218 et seq. 
Efficiency, 96 et seq.; 139 et seq.; 

as affecting wages, 198 et seq.; 

218 et seq. 
Enterprise, Ch. XV; 282 et seq.; 

450 et seq. 



Enterprisers, 19; 283. 
Entrepreneur, 283. 
Exchange, 37 e^ seq. 
Exploitation, 289; 301 et seq. 
Exports and imports, balance of, 

413 et seq. 
Export taxes, 418. 

Factory system, 127; 462. 

Farming, 136. 

Fashion, 35; 52; 53. 

Federal Reserve law, 354 et seq. 

Finance, 336 et seq. 

Financial institutions, Ch. XVII; 

XVIII. 
Fisher, Irving, 332. 
Foreign exchange, Ch. XIX. 
Foreign trade, 12; as affected by 

changes in value of money, 398; 

regulation of, Ch. XX. 

Gold mining, 163. 

Goods, 27; free, 6 et seq. 

Good will, 295 et seq. 

Great War, 13; 98; 100; 147 et 

seq.; 153; 174; 215 et seq.; 

278; 284; 293; 302; 309; 325; 

329; 331; 366; 39S; 396; 398; 

405; 418; 421; 422; 426; 443; 

444; 461; 467- 
Gresham's law, 315 et seq. 

Habits of workmanship, 144 et seq.; 

397- 
Holding company, 178 et seq. 
Human qualities, as wealth, 6. 

Imitation, 34 et seq. 

Immigration, 210. 

Imports and exports, balance of, 

413 et seq. 
Improvements, 116 et seq.; 196 

et seq.; 253; 298 et seq.; 451. 
Income tax, 421. 
Increasing returns, 117. 



INDEX 



479 



Inequalities, 453. 
Injunction, 229. 

Integration of industry, 173; 182. 
Interest, Ch. XIV; 21. 
International trade, Ch. XIX. 
Inventions, 130; 162; 295; 452. 
Investment company, 378 et seq. 
Investments, 364 et seq. 

Joint products, 61 et seq. 
Joint stock company, 159. 

Kansas Court of Industrial Re- 
lations, 235. 

Labor, dejSnition of, 186 et seq.; 
efficiency of, 96 et seq.; hours 
of, 135; 147 et seq.; marginal 
productivity of, 193 et seq. 

Labor organization, Ch. XII; 139; 
150; as affected by consolida- 
tion, 226; objects of, 220. 

Labor turnover, 149 et seq. 

Laisser-faire, 449 et seq. 

Land, 243; capitalization of, 277; 
rent of, 91 et seq.; 270 et seq. 

Land Bank, 382 et seq. 

Legal tender, 312 et seq. 

Leisure class, 2; 20. 

Life insurance company, 384 et seq. 

Loans, varieties of, 342 et seq. 

Lumber industry, 153. 

Luxuries, 2$ et seq. 

Management, 127; 135. 

Market, 15 et seq. 

Mediaeval economy, 405; 458; 

491. 
Money, Ch. XVI; 12; functions 

of, 307 et seq.; increase of, as 

affecting prices, 317 et seq.; 

paper, 319 et seq.; 329 et seq.; 

stabilization of, 332 et seq.; 

value of, 315 et seq. 
Monometallism, 312. 



Monopoly, 18 et seq.; 57 e/ seq.; 
295 et seq.; 454; 458; 459 et 
seq.; 469 et seq.; governmental, 
69. 

Monopoly profit, 299 et seq. 

Mortgage, 342. 

National defense, 443. 
Nationalization of railways, 471. 
Natural agents, 243. 
Necessaries, 25 et seq. 
Needs, future, 7. 
Negotiable paper, 342. 
New Zealand, 234 et seq. 

"Overhead," 142. 
Owen, Robert, 135. 

Paper money, 319 et seq.; 329 et 
seq.; 406. 

Patent, 69; 295; 297; 299. 

Picketing, 229. 

Polakov, Walter, 146. 

Political economy, 21. 

Population, increase of, 210 et seq.; 
as affecting rent of land, 275 et 
seq. 

Preferential shop, 223. 

Price, Ch. II; 21 et seq.; 40 et seq.; 
abnormal, 51 et seq.; fluctuat- 
ing, 50 et seq.; market, 41 et 
seq.; monopoly, Ch. IV; normal, 
Ch. Ill; normal as related to cost 
of production, 54 et seq.; per- 
sonal, 41 et seq.; stable, 49 et 
seq.; 69. 

Price control, 455; 461. 

Price cutting, 72 et seq. 

Price fixing, 302 et seq.; 327. 

Prices, agricultural, 59 et seq.; 
278; as affected by credit, 320; 
as affected by increase in money, 
317 et seq.; general rise of, 293; 
rising, as affecting wages, 318 
et seq. 



480 



INDEX 



Producers, marginal, 63 et seq. 

Production, 10. 

Profit, Ch. XV; 286 et seq.; as 
affected by price changes, 325; 
exploitative, 289; monopoly, 295 
et seq.; 299 et seq.; 454; mo- 
nopoly, capitalization of, 297; 
relation to progress, 298. 

Profiteering, 301 et seq.; 327. 

Prosperity, 325. 

Protection, effect on wages, 430 
et seq. 

Public finance, 11; 365 el seq. 

Railways, nationalization of, 471. 
Refrigeration, 124 et seq. 
Regulation, government, 457 et seq. 
Rent, Ch. XIV; as affected by 

increase of capital, 27 et seq.; 

classical concept of, 263; gross 

and net, 265; of land, 91 et seq.; 

1 01; of land, as affected by 

growth of population, 275; rise 

of, 272 et seq. 
Reserves, banking, 353 et seq. 
Retaliation, 445 et seq. 
Risk, 203 et seq.; 257 et seq.; 285 

et, seq.; 371. 
Russia, 426; 449. 
Russian revolution, 9.' 

Salesmanship, 36 et seq.; 183, 
Santo Domingo, 371. 
Saving, 243 et seq.; 367; 455. 
Savings bank, 379 et seq. 
Scientific management, 145 et seq.; 

150 et seq. 
Securities, 368. 

Sherman Anti-Trust Law, 178. 
Shoe industry, 123 et seq.; 130. 
Silver movement, 327 et seq. 
Slaughtering, industry, 164; 167 

et seq. 
Slavery, 2; 14; 15; 147. 
Smith, Adam, 12. 



Social economics, 21; 23. 
Socialism, 469. 
Specialization, Ch. VII; 10. 
Speculation, 374 et seq.; 406. 
Speculator, 385. 
Standardization, 151 et seq. 
Standard of living, 26; 148 et seq.; 

199; 208 et seq.; 430 et seq. 
Standard Oil Company, 72; 176; 

179; 184. 
Stock exchange, 374. 
Stockholder, 368. 
Strike, 228 et seq. 
Supply, 44 et seq. 
Sweating system, 289; 294. 
Syndicates, 1 74. 

Tariff, 12; 419 et seq.; 450. 

Taxation, 10; 417; 420; 421; 469. 

Taxes, direct, 420; indirect, 420 
et seq. 

Trade union, 221 et seq.; 463; 
benefit policies, 224; restric- 
tions, 223 et seq. 

Transportation, 83 et seq.; 124 et 
seq.; 156; 158; 165 et seq.; 171 
et seq.; 176; 461. 

Trust, 177 et seq. 

Underwriting syndicate, 377 et seq.; 

385. 

Unemployment, 132; 325. 

United States Steel Corporation, 
173; 176; i7g et seq.; 184; 370. 

Usefulness, 28. 

Usury, 466. 

Utility, Ch. II; 27; 47; dimin- 
ishing, 28 et seq.; effective, 30 
et seq.; 47; final, 30; marginal, 
30- 

Value, Ch. II; 8 et seq.; as affected 
by imitation, 34 et seq.; as 
affected by salesmanship, 36 et 
seq.; intrinsic, S3 et seq.; per- 
sonal, 33; relation to wants, 9 



INDEX 



481 



et seq.; social, 34; subjective, 
S3; subjective exchange, 40. 
Violence in labor disputes, 229. 

Wages, Ch. XI; 21; as affected 
by efficiency, 198 et seq.; 218 
ei seq.; as affected by fall in 
interest, 197 et seq.; as affected 
by protection, 430 et seq.; as 
affected by rising prices, 215; 
318; contract, 189 et seq.; de- 

. finition of, 188 et seq.; regula- 
tion of, 464 et seq. 



Wants, 24 et seq.; diminishing in- 
tensity of, 26; elasticity of, 25 
et seq.; future, 10 et seq.; in- 
satiability of, 2 et seq.; relation 
to value, 9 et seq.; social character 
of, 2 et seq, 

"Waste in Industry," 143; 153. 

Wealth, 22 et seq.; as a means, 
3; as an end, 3; definition of, 
i; 5 et seq.; as human qualities, 
6. 

Workmen's compensation laws, 207 
et seq. 



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